Profit & Loss talks to Vibhanshu Bahuguna, regional manager, APAC, at TradAir, about how technology is changing the FX businesses of regional banks, how firms should be differentiating between various white label product offerings and where to expect growth amongst EM currencies.
Profit & Loss: The latest BIS figures show that the volume of FX trading activity conducted by regional banks increased 45% compared to the 2016 survey. After a long period of FX volumes consolidating in the top few global banks, do you see that trend reversing and regional banks becoming a more significant part of the FX ecosystem?
Vibhanshu Bahuguna: Growth in EM pairs has been a large contributor for the increased market share of the regional banks. Most EM pairs such as INR, KRW, CNY, SGD, etc, have seen growth, according to the 2019 BIS survey. Regional banks have a good local/onshore presence, which gives them a better control over their franchise, and they also tend to have a large amount of flow from hedgers and corporates, hence they are more competitive in such pairs. It’s unlikely that the trend will reverse for G7 pairs, where global banks still have better technology, global access, etc, to their benefit.
P&L: What are the biggest challenges that you see regional players grappling with in FX? How are they overcoming those problems?
VB: Some of the biggest challenges amongst regional players are geographical fragmentation, technology and the regulatory framework in which these firms must operate.
Geographical fragmentation is the biggest challenge in Asia, where five regions or countries could each have a very limited daily turnover – for example, there could be just three yards worth of business, but it might need to be accessed and serviced individually. Banks are trying to align themselves by developing synergies amongst markets in which they have presence, so they might centralise G7 trading in one location or service their regional corporates under one book, etc. Technology is playing an important role in helping them achieve these regional ambitions.
P&L: Is technology levelling the playing field in FX? In what areas is it helping regional firms compete in this highly competitive market?
VB: Technology does create a level playing field, but each bank adopts it uniquely in their workflow and hence the outcome can be different. One of the areas where technology can be of immediate benefit though is in providing price distribution to a large client audience.
P&L: Does the ability of firms to buy technology that will let them create and distribute their own prices more easily play into these themes of democratisation? What other tools do they need in a product to help support the price generation/distribution?
VB: Having the ability to generate and distribute prices needs to be powered by very strong underlying risk management tools, which can afford you all the necessary protections. P&L, position and volatility based protections are the most widely used. For distribution, it is also essential to have the ability to create synthetic crosses, where you could decide to warehouse one currency and back-to-back another. The ability to separate price construction and coverage is also important from a P&L perspective. All these tools can be used in combination to distribute prices to a larger audience without compromising on client yields.
P&L: When it comes to white labelled products, how should firms be differentiating between different providers in the market?
VB: There aren’t that many solutions in the market that can provide a full suite of white label, aggregation and pricing engine type solutions to suit a regional bank, although there might be many products that aspire to do this. Banks have stringent internal and external guidelines that they need to comply with and this requires a huge technology investment, resources and domain expertise from the provider of the white label product.
Banks usually look to differentiate providers in the market based on: their ability to manage real-time credit, positions and P&L for over 500 downstream customers; flexibility of both cloud and on-premise type solutions, volatility, P&L and position–based protections; secure 2FA and e2ee type encryptions, data security and disaster recovery.
P&L: Do you see client demands around margin and credit management evolving?
VB: Client demands are around better utilisation of credit. There is growing demand from clients to their brokers and banks for cross margin benefits for currencies trades on listed exchanges and OTC. Clients also prefer their PBs to net settle across value dates, rather than a net settle only for same value dates and gross for different dates.
P&L: Again, coming back to the latest BIS numbers, the currencies of emerging market economies continue to gain market share, reaching 25% of overall global turnover – logic suggests that this will continue, but is the growth likely to be uneven? And if so, which EM currencies do you expect to see leading the way in terms of increased trading activity?
VB: The reason for the growth of EM pairs over the last few years has been due to a wave of capital account liberalisation in emerging market economies. This triggered a surge in capital inflows and consequently heightened the currency risk faced by foreign investors. The reasons for this growth have been under-developed domestic markets (especially financial derivatives), controlled access to onshore markets and a sharp rise globally in the size of derivatives markets in these currencies.
This raised the demand for a currency market outside the reach of local regulations. As derivatives markets evolved, the speculative search for underlying yield moved out of the developed world into more esoteric assets. Such activity becomes particularly noticeable during times of stress as offshore risk spills over to the domestic exchange rate through entities that have a presence in both onshore and offshore markets. We expect increased activity in all the ASEAN pairs, INR, KRW, CNH, MXN and ZAR.
P&L: Does the growth of EM currencies suggest good upside growth for NDF products going forward? Is this an area of focus for you?
VB: EM pairs have always been TradAir’s strength, in fact our first client in 2011 was a regional bank for whom we developed a pricing engine for an EM pair. Over the last three years, Tradair has invested a lot of time and effort in building workflow tools to help clients trade NDFs more efficiently, and over the past year we’ve really started to see the benefits of this.
However, the growth in EM pairs has also caught the eyes of some central banks. There is a study, conducted by the Reserve Bank of India, which suggests the influence between offshore and onshore exchange rates goes both ways in normal times, that is, it is bidirectional. The study also observed that during the last two stress episodes (the taper tantrum and the 2018 emerging markets crisis), the relationship turned unidirectional, with the NDF market driving onshore exchange rates. Therefore the study concludes that as NDF volumes have increased, they have begun to play an important role in both price discovery and driving volatility, particularly during heightened uncertainty periods.
P&L: The Chinese FX market has been slower to open up and internationalise than some predicted. Do you see China as a good business opportunity in the near-term or is it still too difficult to do business there?
VB: China is the second largest country in terms of GDP and hence it is difficult to ignore it just because of the scale of opportunities it offers. The reality is that Asia is a fragmented market, with each country having its own nuances from a business standpoint. In Asia, one needs to identify a market and stay invested and committed to that market for 18 to 36 months before you start seeing the benefits. From TradAir’s perspective, given our wide range of offerings, we definitely see opportunities in the region.
P&L: For the first time ever, five of the top 10 FX trading hubs by volume are in APAC, according to the BIS. While London will clearly remain the pre-eminent FX trading hub for the foreseeable future, do you see the industry’s centre of gravity shifting towards Asia?
VB: In terms of GDP, Asia as a region is expected to grow by around 5.5% next year, accounting for nearly two-thirds of global growth, and the region remains the world’s most dynamic by a considerable margin. Asia is already a leader in many aspects of the digital revolution and it’s only natural to expect that to continue for the next three to five years. But, the gravity of the FX market won’t shift, as London still has a market share of almost 45%.