It’s no secret that recent regulatory requirements have put FXPB business models under increased pressure. But some firms also see regulation as an opportunity to change how their businesses operate in order to win new business, as Galen Stops reports.

When questioned about the extent to which a combination of the Basel III regulations and the SNB event had caused a contraction in the FXPB space, there was some pushback from certain service providers.

“I think that there’s a misperception that there has been a wholesale contraction in the FXPB space,” says John O’Hara, global head of FXPB and FX clearing at Societe Generale.

He says that while the biggest FX flow houses may have rationalised their client bases, they continue to invest in the business, and that others, such as Societe Generale, continue to value FXPB as one of the three pillars of its clearing business and as a means of gaining traction in other prime services business lines, effectively using FXPB as an anchor for additional mandates.

“If you look at the firms that were actually growing their FXPB business and taking on new accounts over the past couple of years, it has more than offset those that have shut down or scaled back,” adds O’Hara.

Marcus Butt, head of FX prime services at NatWest Markets, adds, “There are a number of perceptions about the FXPB business that I don’t think are 100% correct.”

Butt agrees that banks in general have had to become more thoughtful about both the costs and the bottom line contribution of their FXPB businesses, and he agrees that new regulations, from Dodd-Frank to Basel III to MiFID II, have “fundamentally changed the cost structure of banks”.

He adds, however, “I think the interesting aspect is really that it’s not had the same impact on all of the banks, so different banks are looking at their business overall and responded to these regulations in different ways. I think this has actually helped, because it has meant that people have started specialising to support different types of business.”

Kate Lowe, head of FXPB at Standard Chartered Bank, goes even further, claiming that, rather than experiencing a rebound period, FXPBs are undergoing a period of “reinvention”.

Getting Ahead of Regulations

Elaborating on this, Lowe explains that historically one of the key elements that would drive both the relationship with the clients and the rationale for having an FXPB business was execution. FXPB was there to bring clients into the bank, create sticky relationships and more execution for the franchise business, as well as an upwards cycle for the bank.

“What we’ve seen in recent years though, is that the driver behind having a PB relationship is changing,” Lowe
says. “Whilst credit is still important for a lot of end clients because it allows them to access the best execution platforms and the best liquidity possible, they are also looking at other factors that are equally important. They don’t simply look at who their top three liquidity providers are and select an FXPB out of those, I think they’re looking for FXPBs that are plugged into what is happening with regulation and can help them solve some of the problems that they’re experiencing as a result of this regulation.”

One example of regulation that some clients appear to be looking for help with is the margin reform coming into effect under EMIR, the European Market Infrastructure Regulation.

Although in the past it hasn’t always been clear to what extent these margin rules will include FX products, it looks likely that in 2018, counterparties will have to begin paying variation margin (VM) on deliverable FX swaps. For counterparties with multiple bilateral relationships, it could make sense for them to consolidate these and trade through a PB instead, especially if they have never had to post margin in this way before.

“With an FXPB, you are only facing one counterpart. So if at one point you need to pay variation margin or initial margin, then it is easier to use this model from an operational and legal standpoint rather than having multiple counterparts. Variation margin is coming for swaps in Europe next year, and at some point it will be introduced for options and NDFs, and so only having one counterpart can make it easier for some clients,” says Vincent Bonamy, head of global intermediary services, GFX and commodities at HSBC.

As Lowe explains: “What we’ve seen in the industry is a big shift from the execution-heavy driver on both the client and bank side towards creating an FXPB offering that is complementary with other prime services within the bank, but also services clients from a regulatory perspective. This means providing them with services like margin optimisation, portfolio compression, being able to offer maximum access to any electronic platform and creating operational efficiencies.”

However, she’s quick to add: “I don’t think we’re at this reinvented stage yet because we’re still very much in the process of understanding the needs and requirements of clients in response to changing regulations.”

Targeting Asset Managers

This constantly evolving regulatory landscape can make for a challenging environment within which to operate an FXPB business, and Ryan Connolly, global head of FX prime brokerage at UBS, says that the cost impact of these changes is still uncertain.