When the Bank for International Settlements (BIS) published this year’s version of its FX turnover survey there was much scratching of heads in the FX industry at its finding that $6.6 trillion was traded every day in the FX market. Not only was the survey taken in what was a quiet month by most standards and did not reflect the growth seen in the local FX committee survey, those areas that may have contributed to such a growth – emerging markets being one – actually did not grow that much in notional terms.

There was one area of the survey that doubled down on the mystery however, and that was a section of the counterparty report entitled simply “other”. This data point saw turnover almost treble from the 2016 report to $524 billion from $191 billion. This publication speculated, as many in the industry did, that this was volume from retail aggregators, however the point was made that surely this flow would show up in not only the retail-driven data point, but also in the prime brokerage data?

To a degree the answer did lie in the PB data, which rose by $601 billion across all FX products between the surveys and indeed a study contained in this week‘s BIS Quarterly Review highlights how. One of the footnotes to a table lays out exactly what is covered by “others”, specifically it states it includes “securities firms, financial arms of corporates, retail aggregators or institutions performing the role of so-called prime of prime”.

Although it does not explain exactly why retail aggregator flow is not deemed as “retail driven” in the report, this line does at least explain where a lot of the growth has come from. As prime brokers squeezed the client portfolios further, more and more firms, including some reasonably large ones, fell into the prime-of-prime world. This does not, of course, explain why this growth was not picked up in the local FX committee surveys that were released in July for the same month of April 2019, looking across the three year period in these surveys, the prime brokerage numbers were broadly unchanged.

The latest report also points out a function of the prime brokerage market can also boost the numbers in the BIS survey, especially when PB client deals with PB client. The report states, “The rising prevalence of PB has implications for the turnover figures recorded by the Triennial. Even though effectively [the client] trades with [an executing broker], there are actually two trades taking place which need to be recorded in the survey. In a scenario where two prime-brokered clients face each other directly, and their respective prime brokers each record another trade with their prime-brokered customer, a give-up trade executed by the two prime-brokered customers could create three times the turnover of a direct transaction.

“Hence, FX PB volumes to financial customers, which capture the amount of credit backing prime-brokered customer trades, may exceed the associated give-up trades in the inter-dealer market,” it explains.

Although this does not solve one the many paradoxes in the original report – PB volumes surging ahead at a time when the major PBs were trimming their client list – it is most probably explained by the capturing of prime-of-prime volumes, something that finally puts an empirical measure on what has largely been to date something of a mystery to anyone not directly involved in the business. There is also the fact that, as the report points out, prime brokerage volumes were still restrained in the 2016 thanks to the continuing fallout of the 2015 SNB de-pegging event.

The retail aggregator/prime-of-prime volumes probably make up the majority of the “others” volume, hence this segment is turning over not far short of $200 billion per day in spot,  just short of $100 billion in outright forwards and a hefty $187 billion in FX swaps – the latter largely likely to be the result of the rolling of positions, although it could be where the influence of securities houses and the financial arms of corporates make their presence felt.

As far as the aggregators and prime-of-primes are concerned, this would also explain how the spot numbers, with their growth of 20% from 2016, do not marry up with the data reported by most third-party platforms, as these participants mostly prefer to build their own private aggregation pools and partner with the liquidity providers (who in turn often provide better pricing because it is a more controlled environment than an ECN or multi-dealer platform). What this doesn’t explain, again, is how this development wasn’t flagged in the local FX committee surveys, although there are different reporting styles with some, it seems strange that increased PB volumes were not tracked.

Given the continued decline in dealing between the major dealers, the analysis also throws up another scenario in the modern FX market – one that the participants concerned may not be too happy about. Noting that the growth in volumes involving non-financial counterparties had largely kept track with developments in global trade, the analysis also points to the greater role played by non-bank firms. This suggests that more non-bank firms are trading with other non-bank firms – a situation in the past that has been anathema to these players. The increased activity by these players, which also drove a good increase in PB volumes as they have historically been very keen to price retail aggregator/PoP flow, cannot just be down to these players connecting with clients, although that would have been a part of the growth.

Whichever way one looks at it, however, the non-bank players are having an increased influence in FX markets, especially spot. The reaction of the banks, and perhaps more importantly the regulators, to this continued growth will be interesting to view. The sense at the moment is that the banking industry is continuing to hold the reins on its collective FX businesses tightly and this should provide more opportunities for the non-bank industry – assuming it can monetise in what is becoming an increasingly tougher market environment.

For the regulators, the question from this analysis could very much be what to do with the non-bank firms – especially as they start to build what can only be described as client franchises?

Colin Lambert

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