The very fact that more and more people from the platform/connectivity world are talking to me about FX swaps tells me that, as I have suggested many times before, change could be coming to this segment of our industry. Ideas and initiatives are all fine, however, but will they translate into definitive market structure change?
I was pulled up by a senior industry figure recently when I made the admittedly careless comment that FX swaps were not automated – they are, it’s just different to the spot market that we always seem eager to compare it to. Having said that, the latest UK FX Joint Standing Committee (JSC) data indicates that the e-ratio in the world’s biggest FX swaps market has barely changed in the last five years – in fact it has edged lower to 34% from 34.25% in April 2014.
Where things have changed is down to where people are trading – there has been a definite shift over that five year period away from the single dealer venues to multi-dealer channels, the former’s share has almost halved to just under 6% with the slack being taken up by multi-dealer platforms mostly, but also to a degree the ECNs. This tells me that customers have gone most of the way to automating how they execute their flow, and they are putting their dealers in competition, which is as it should be – after all, when it comes to the big issue around FX swaps markets, credit, this customer business is the low-hanging fruit.
What is striking about that JSC data, however, is that the share of the voice brokers has also barely changed – in fact it has actually risen from 28 to 28.2% over that five-year period. Thus, as I have noted in these pages before, the challenge remains at the inter-dealer level.
Obviously we have an existing ECN in Refinitiv that handles around the $350 billion per day mark in FX swaps volume (the vast majority being in the short dates) and the announcement earlier this year of 360T’s initiative, so things are moving, but are they going to move quicker? Well initiatives are certainly out there, but to succeed they need to tap into an appetite for change, and is that there? I am not sure it is because the bottleneck around innovating this piece of the industry is in the banks – and they seem to always have more on their ‘to-do’ lists when it comes to the e-business than they can ever hope to achieve. Throw in the fact that customers generally seem happy with how the FX swaps market works for them and market structure innovation in FX swaps drifts down the banks’ lists of priorities, meaning disruptors face a much harder task.
The big problem remains credit and, to a lesser degree, transparency. We can talk a good book all we like but we have to face the reality that someone putting in an order for a couple of yards of dollars in the three months is going to influence the market. That type of transparency is just no good for this type of market, so the solution is darker trading, maybe not a dark pool as such (although I still think that is the best solution), but the greater use of Iceberg orders perhaps and minimum trade thresholds.
The credit issue is the one that always dampens the spirits of evangelists in this space, but even here solutions can, and should, exist. I understand it is not so simple as pre-loading credit onto a platform and trading away, but something could be done. To my mind the solution is for banks to better utilise their risk weighted assets (RWA) pricing by making that available on platforms. It would involve a lot more pre-loading and be a more complex process to manage but this is FX swaps – markets don’t move that quickly and we are not, thankfully, at the stage where they are being quoted to six decimal places. The intra-day risk modelling would be a challenge, although banks seem to be able to manage this perfectly well for their clients using technology, so why not do it for each other?
If the past five years are anything to go by then, evolution in FX swaps will continue to drag its feet, however that period didn’t not see many attempts at innovation and disruption – the next five are likely to and that means change could be coming.
One question this raises is what does this mean for the voice brokers? That’s a tough one because that channel remains the preferred option for traders looking to trade mid-market, but the better market data available may diminish this advantage over the coming year or two. It is hard to see how voice brokers can fight such a change off, and it could be that this becomes yet another product set lost to the e-channel. They can increase the level of automation in their businesses – there are plenty of people who believe the hybrid model remains the best – or perhaps there will be one other possible development that is, I have to confess, very left field.
We all know that the exchange groups around the world have been hoovering up OTC electronic trading venues over the past few years, will one of them eye up a voice broker, or at least part of the business? Take Deutsche Boerse as an example; it has been thwarted in its attempt to buy the FX platforms of Refinitiv, is seeking to build its OTC presence further, and has an FX swaps initiative live that it would love to be able to push more volume through. Is a voice broking FX swaps (and possibly options) business a potential acquisition?
As I say, that is pretty left field but we have seen stranger things happen. Either way, I suspect that the next five years in the FX swaps market will look radically different to the last five.