I received quite a lot of feedback from the story we ran earlier this week about Goldman Sachs launching an FX swaps ‘axe’ GUI, and while the sample may be skewed by the type of people I talk to, who typically are in the ‘e’ business, it did seem to signify a growing sense in the industry that this market is, finally, ripe for disruption.
Of course, showing axes is nothing new in FX markets, Credit Suisse first did it in spot almost a decade ago and Bank of America, reflecting its then-strength in the product, did the same with FX options. I also recall Deutsche Bank offering axes on FX swaps before, but the sense is the latest move is something new – because I don’t think the type of intra-firm connectivity and data and analytics were available even three years ago.
It is the fact that Goldman is producing a “smart” price that intrigues me – as the article explains, there is a tremendous amount of complexity behind was is a simple screen display. In some sense the axes this greater connectivity and understanding of the bank’s complete risk view bring will help it stand out from the crowd, but at heart Goldman is really looking for smarter matches – it is getting a systematised view of its exposures and, with some analysis, can also express these exposures to the right people.
A couple of years ago I remember being shown Barclays’ RWA swaps pricer, so obviously Goldman is not the only bank looking to create that smarter price, but this methodology seems to go further.
It is, however, only a matter of time before other players reach the same stage and are all able to offer those smarter axes, and when that happens, what effect will it have on the FX swaps market structure? What, you may ask, would a simple ex-spot trader know about it? And that would be a good question, but people I have spoken to this week who doreally understand this space think it could look radically different.
For a start there is the question of easier matching. If more players are able to develop and show these axes – more importantly perhaps have the confidence to show them – then those platforms in the business of facilitating FX swap trading should be licking their lips. For this, at heart, is what the voice broking community does, it matches axes, so if a platform can do the same, in a more efficient manner then surely this is the catalyst for change?
This represents yet another challenge for the inter-dealer brokers because while their FX swaps business has been eroded by automation over the years, the pace of change has been nothing like most people expected a decade ago. Desks in these markets have shrunk, but they are still meaningful contributors to the overall business, but in the major currency pairs at least, one suspects yet another squeeze is coming, There will still be a place for the voice broker in the less liquid currencies I think, but how many brokers does that model support and even there I suspect the creep of technology will continue.
Such an evolution, however, does not represent an easy ride for the platforms, however, because there is still the matter of creating the right model. 360T seems confident its FX swaps mid-market framework will succeed in disrupting the FX swaps market, and I tend to think that if any model will do it, that one will, but looking at the numbers reported by parent Deutsche Borse, the impact is still limited. A back of the envelope calculation (I used a static 1.15 exchange rate to extract the spot element) shows that in the first seven months of this year the platform handled around EUR 66 billion per day in non-spot product. This is up from just under EUR 60 billion for the first seven months of 2019, but obviously February and March 2020 were significant months in terms of ADV.
It remains early days – the same can be said for CME’s FX Link which also seems to have had broadly similar volumes across the first seven months of 2019 and 2020 – but there is a sense that the firms that were using the 360T platform three years ago, are still using it today. There seems to be a systematic nature to the non-spot volumes which suggests regular hedging programmes in operation, and if that is the case then the model is vulnerable to a service like FX Hedgepool which is very much about matching systematic hedging flows.
It’s not all threat, however, for opportunity also exists. For a start, FX Hedgepool is aimed at buy-side to buy-side matching which is a limited (but still sizeable) segment of the market, whereas 360T is very much targeting the rich seam of bank-to-bank. Equally, as more initiatives like the Goldman Sachs one, come online, the 360T model will benefit, because banks can stream a smarter price to the platform, meaning easier matches – although of course it still has to convince the banks that it is the venue to stream to, it should not be forgotten that the Goldman model is very much about leveraging its single dealer platform.
There is also the broader risk and regulatory aspect to be worked out. I do not see why, as they have done with Refinitiv spot Matching and EBS Market, banks cannot pre-load FX swaps credit into a system for each other – perhaps they have – but this is only a small part of the issue. The complexities around forward pricing mean that a simple credit check is not going to be enough going forward – as the Goldman initiative highlights, there are many more inputs to the price than that.
The eventual winners in this space will be the platform(s) that can work with one of the fintech firms that have sprung up around the world seeking to ease the credit and capital burden on the banks’ FX swaps business. Some of these initiatives are showing real promise as the latest tech is brought to bear on the issue, but I still think the next bold step will be somehow linking these services to a large liquidity pool on a trading platform.
As someone who has been wondering about the FX swaps space for more than a decade, it seems to me it is going to be a fascinating year or two ahead in this market. There will be winners and losers and I suspect the losers will suffer a lot more than they did in the spot space, because this is no spot market where it is easy to drag in enough business to survive, but not thrive. The FX swaps market is often given more importance in the banks than the swaps as it is part of the funding operation and that means there is a real understanding of the need for deep liquidity pools. The inter-dealer broker market in this space has contracted from maybe a dozen broking firms with FX swaps desks 20-25 years ago to just two or three – this is not a market that likes the idea of fragmentation. Throw in the fact that a lot of the people now running bank FX businesses grew up in the ‘e’ age and you have a recipe for dramatic change, but in this race everyone will most certainly not win a prize.