David Puth, now a strategic advisor at R3, makes the case that the FX industry’s ability to constantly evolve makes it unique amongst financial markets.
Profit & Loss: As you look back over the past 20 years of FX, what stands out in your mind with regards to the evolution of this market?
David Puth: I have always believed that among financial markets, FX is unique. Over decades, it has demonstrated a remarkable ability to regularly reinvent itself through many different economic cycles. People have proclaimed the end of the foreign exchange market many times, but they’ve always been wrong.
P&L: Can you give some examples of this reinvention?
DP: The first modern reinvention was the meaningful expansion by institutional participants into the emerging market space, which began in the late eighties and early nineties. Then in 1997 we had the Asian financial crisis, which led to the devaluation of a number of currencies and, subsequently, a movement from fixed peg currencies to free floating ones. I recognise that this pre-dates the launch of Profit & Loss in 1999, but it was an important macroeconomic event as these dramatically weakened currencies ultimately accelerated the rejuvenation of the Asian economies and led to significant economic growth in the years that followed.
The market again reinvented itself following the creation of the euro in 1999. I think that many market participants felt that there was the possibility that the creation of the euro would spell the end of the foreign exchange market as we knew it. In fact, on the contrary, many new types of transactions came into play and the market continued to grow.
The financial crisis of 2008 was a defining moment for markets in general, and for FX in particular. While many of the more credit intensive markets were unable to operate effectively for days during the crisis, the FX market proved to be extraordinarily resilient. Although people tend to forget this, it was actually a record year for FX activity and, for many firms, a year of record profitability in their FX businesses. The FX market continued to operate, without interruption during the Lehman failure, in part due to the effectiveness of CLS.
Of course, over the past 20 years we’ve also seen FX reinvent itself through the extraordinary growth of electronic trading – many of the millions and millions of transactions that take place every day would not be possible without new technology. This has enabled market participants to effectively transfer risk seamlessly and effortlessly and has led to FX becoming the largest, deepest market in the world, trading 24 hours a day, five-and-a-half days a week.
P&L: Given this constant reinvention, are you confident in the FX market’s ability to continue growing?
DP: The foreign exchange market is alive and well, and while obviously we are going through a period of relative quiescence, I expect that this time will pass. It is widely acknowledged that this low level of volatility is driven in part by stability in interest rate differentials. Eventually there will be a cyclical change, there will be a monetisation of debt and interest rates will start to rise, at which point the interest rate differentials will drive differences between the currency values. There is no reason to think that the FX market won’t continue to expand in the years ahead.
P&L: You referred to CLS before, and obviously you were the CEO there for a number of years. Do you think that the launch of this piece of shared infrastructure represents one of the more significant developments in FX over the past 20 years?
DP: CLS was a critical addition to the marketplace. At the time it was launched, we underestimated the impact that it would ultimately have.
Here’s one anecdote that perhaps illustrates the importance of CLS: one of my early meetings after taking over as the CEO of CLS was with the head of a medium size bank who told me that in the decade since CLS had launched they had been able to grow the size of their FX business tenfold. As a smaller organisation, prior to CLS they had a more difficult time getting both credit lines approved and being approved by others. CLS enabled them to become an active participant in the global foreign exchange market.
That’s what CLS did – it enabled explosive but safe growth of the marketplace.
P&L: Do you think it would be harder or easier to launch such a large piece of shared infrastructure today?
DP: I think it might be easier just because the market has seen it work so effectively.
CLS was a massive undertaking, but it had full support and encouragement from the world’s leading central bankers to come together to solve a significant risk issue.
That central bank support helped get CLS going. Now, the catalyst will likely come more from the fact that banks and institutional players will continue to focus on ways in which they can reduce costs. Mutualisation of expenses could be a driving force for new shared infrastructure.
P&L: It has been suggested by a number of people recently that FX as a market is set to move away from T+2 for settlement to something more real-time. Do you agree with this assessment?
DP: Without question. T+2 settlement is definitely something that should disappear in the not too distant future. CLS has recently launched a same day settlement system, which is the first step towards safe, nearly real-time settlement.
Today there are a number of payments systems that are enabling money to be transferred immediately, but they are, in most cases, delivery versus payment (DVP) settlement systems.
Same day settlement has existed in Canada for some time. The idea that it takes two days or more to transfer the money in an age of instantaneous payment just seems strange. I expect that to change.
P&L: You were also one of the many people who worked on the creation of the FX Global Code and were subsequently a vocal advocate of it. Do you view the creation of the Code as an important milestone for the industry?
DP: I think it was extremely important for the market. It demonstrated that the market itself could find a way to address industry challenges by bringing together both private and public sector participants to agree on best principles for the industry. It was a significant and successful effort. Appropriately, there are other markets currently working together in similar fashion to help business operate more effectively and fairly.
P&L: You’re now working as an advisor to R3, do you expect blockchain or distributed ledger technology to have a big impact on the FX markets, or even just financial markets more broadly?
DP: We are already seeing a number of active uses of blockchain to help create greater efficiency and security with the exchange of information. Increasingly, we see the potential for blockchain to secure the exchange of tokens. R3’s blockchain platform, Corda, can provide a trusted, immutable record of transactions, and I see that continuing to move towards greater scale. We are not involved in the crypto space, but we do have a vehicle that enables the settlement of digital assets and I expect that the use of this will grow quite significantly.
I am very confident in the future of blockchain to provide efficient solutions to organisations for the movement of financial assets, as well as the movement of information.