Does FX still have the ability to innovate the way that it did 20 years ago? Galen Stops finds the industry divided on this important question.

When Profit & Loss launched 20 years ago, the FX market looked very different than it does today. Much of the industry was still trading via voice channels, pricing was incredibly opaque and banks were very much at the epicentre of the markets.

Moreover, market sources remember that the staff at the banks were given a huge amount of freedom – freedom to take large positions in the market, freedom to come up with creative new products and the freedom to innovate within those organisations.

“If you ask me what’s the major difference between now and 15 or 20 years ago, I’d probably say it’s the level of creativity that the market is willing to embrace,” says Andy Coyne, co-founder and chief product officer at Cobalt. “Back then, e-commerce was really just starting to take off, so you had new sales teams being created that didn’t exist previously. Prime brokerage became electronic and as a result of all this, you saw a ramp up in terms of trading volumes in the market. It was a very interesting time and I look back with great fondness on the creativity that occurred during that period.”

Similarly, Simon Wilson-Taylor, head of EBS Institutional at CME Group, comments: “The banks were a hotbed of innovation and the biggest change I’ve seen in FX is how, over time, this has all been locked down.”

What happened that so blunted this innovation?

A number of things, the most obvious and prominent being the financial crisis in 2008 and the subsequent slew of regulation that followed it.

The Volcker Rule stopped banks taking risks in a very literal sense, as they were forced to wind down their prop trading activity in the market, while Dodd-Frank in the US and later Mifid II in Europe simply sucked up an enormous amount of resources, both in terms of capital and time, within the banks. Basel III imposed higher capital requirements on the banks, leading to a lower return on equity and less capital available to invest in new products, services or ideas.

Andy Coyne, Cobalt

Culturally, banks became much more risk averse as a result of all these new rules, something that was sharply exacerbated in FX by the various scandals that have now seen these banks pay over $10 billion in fines and spawned a number of court cases which have seen their former employees in the docket.

“Innovation has been stymied because everyone’s nervous about making a misstep and as a result, there’s less inclination to take risk,” says Coyne.

Short-Term Fixes to Long-Term Problems

There is also the issue that much of the FX market is simply more commoditised than it was 20 years ago.

“It’s definitely harder to innovate now because this space is very competitive, spreads are so narrow and there are so many technology solutions that offer easy access to liquidity,” says Jill Sigelbaum, head of FXall at Refinitiv. “Access to execution has become kind of a commodity, for G10 it’s the same liquidity providers accounting for most of the liquidity across all the major venues, and so the differentiator now is really the workflow. Even on the post-trade workflow side that has become pretty commoditised because it hasn’t changed in so long. It’s very hard to change back office infrastructure because operations departments tend to be the most risk averse.”

Then there is the challenge of legacy infrastructure. Most major banks today are really an amalgamation of numerous banks that have merged over the years and decades, which often have different internal technology and infrastructure in place. For example, Coyne cites one bank which says it is spending $1 billion a year on its post-trade FX operations because it has multiple offices and branches duplicating both copies of trade information and the processes around the trading.

“I look at this and think: these are only FX trades, why is it so complicated? Because over the years we have allowed short-term fixes to cloud the long-term. The result is that now, with new technology available, we have to dedicate time to undo these processes,” he adds

In addition, some of this technology and infrastructure is mission critical for the day-to-day running of bank’s FX operations, meaning that it becomes significantly harder – and more risky – to try and replace it.

Another factor that some market sources say is responsible for the slowdown of innovation at the banks is that they can no longer attract the top intellectual and creative talent in the manner in which they once could.

Chip Lowry, State Street

As one FX veteran who began their career well prior to the launch of Profit & Loss puts it: “You have to remember that back then anyone who came out of college and wanted to make a lot of money knew that they needed to be in a financial institution, so the best and the brightest people all went to these firms. Now those smart, innovative people want to go and work in tech firms or in Silicon Valley, less and less of them are coming into financial markets.”

Other sources claim that the intrinsically global nature of the FX market means that it is harder to institute broad changes in the industry compared to other asset classes that are more localised to one specific jurisdiction.

Looking Outside the Banks

There is also an argument that innovation hasn’t necessarily slowed in FX, it’s just moved out of banks and other large, heavily regulated financial institutions.

“I can tell you that in large financial institutions, either the buy side or the sell side, the process that’s required now internally to get things done is just an order or orders of magnitude more involved because there’s so much more governance and scrutiny around it. Where a bank could have been very nimble 10 or 15 years ago, it’s much harder to be nimble now, especially if you’re a globally systematically important bank (GSIB). So I think you’ll see more innovation coming from the non-bank space where the constraints are looser and it’s easier for them to fail fast and then recover,” says Chip Lowry, senior managing director at State Street Global Markets in Boston.

Similarly, the FX veteran comments: “What we’re currently seeing is that institutions needing to innovate are doing so via acquisition because they can’t build innovative things anymore. One example of this is State Street buying BestX and Charles River and now they’re trying to piece things together. Simultaneously, some of the brightest and more experienced people from the banks have left these firms in order to innovate, sometimes building things that can be sold back into the sector. So it’s really just a transfer of where innovation can occur, which is no longer in banking.”

Talking to a number of market sources it seems that bank innovation labs in particular tend to attract a combination of withering scorn and amusement amongst the industry.

But as previously stated, just because the banks can’t innovate anymore, this shouldn’t indicate an end to creativity in the FX industry. After all, while the banking sector in general might not be able to take the same risks that it once could in the FX markets, innovative and technologically savvy proprietary trading firms have entered the space as a result. Moreover, banks don’t dominate the FX markets the way that they did 20 years ago. It shouldn’t really matter, for example, if innovation is moving out of the banks and into fintechs given that these firms will still continue offering new products, tools and services to the FX market.

Jill Sigelbaum, Refinitiv

Yet some argue that the role of banks as conduits in the FX market means that an inability to embrace innovation in these institutions will inevitably slow it down more broadly across the market.

“Banks are well placed to have influence over the creativity in the marketplace,” says Coyne. “I remember when I was at Deutsche Bank running its FXPB business, I was the first client of a firm called Efidex, who later became Traiana. One of the differences between then and now is a deal could be done between a startup and a bank in very short order and with a lot of ease because the rule-set was very different.”

Similarly, the FX veteran adds: “Innovation has definitely slowed because the innovators in the market still rely upon interconnectivity with the monster institutions. Sometimes that interconnectivity is as simple as doing a FIX connection and other times it requires a very significant approval process inside that institution, which can take years because first of all you have to get people inside that institution to buy into the idea and overcome their fears that this innovation might disintermediate some valuable piece of their business.”

Lower Barriers to Entry

Not everyone agrees with this perspective, however. “I take exception with the claim that banks are not good at innovating,” says Alan Schwarz, CEO of FXSpotStream. “Look at the largest FX banks on our service – you’re going to try and tell me that they’re not innovative and don’t have good technology? I think the challenge that the banks have had over the past 10 years is a constraint on resources, they’ve had to spend some time prioritising non-technology related requirements.”

Alan Schwarz, FXSpotStream

He adds: “Now I see that starting to shift. The banks seem to have dealt with the regulatory matters and now they have more people, money and time to move the focus back to other areas. Yes, there will always be other firms producing technology in this market, but even with the increase in fintech firms I don’t see the FX market being driven by non-bank technology companies to the exclusion of the banks, I just don’t.”

Likewise, a senior industry figure at one large FX platform provider expresses scepticism that it has become harder to innovate in the FX industry. They point out that technology is now more accessible, cheaper and more broadly accepted than ever before, meaning that the barriers to entry for new players coming into the markets have decreased significantly over the past 20 years.

Moreover, the platform source also contends that the claims about legacy technology and infrastructure being major barriers to innovation at banks are often overstated.

“I think that was a problem, particularly five or 10 years ago, but for well-run firms in this space I think that this is an obstacle that they understand and have largely overcome,” the source says.

While regulations might have caused a slowdown in innovation in some areas of the market, it has spurred more in other areas. One obvious example of this is the rise of more sophisticated data analytics tools, such as transaction cost analysis (TCA), that has evolved from the increasing need of market participants to demonstrate that they achieved best execution when transacting in the FX market in order to satisfy regulatory requirements and investors that are more keenly demanding of such analytics following the industry scandals.

A Path Towards Change

While spot FX is largely a commoditised product at this point, Jason Woerz, who recently left Bridgewater to launch a new trading platform called 24 Exchange, says that there is both room and willingness to innovate in other FX products.

Jason Woerz, 24 Exchange

“If you think about the lifecycle and development of a product, with the beginning being phone trading and the end being automated execution, then I think that spot FX has largely run its course,” he says. “Maybe someone will come out with a new, shinier mousetrap, but I’m not sure what the value-add would be. But NDFs still need to go fully electronic and then there’s also a lot of scope for FX swaps and FX options to go the same way. All three of those are much earlier in this lifecycle I mentioned and so there’s going to be a lot of innovation around these products going forward.”

For all this debate about whether or not FX has a problem with innovating, especially in comparison to the past 20 years, Schwarz argues that the industry has always been prone to evolution rather than revolutions.

“Nobody in FX has come out with something like an iPhone, something truly innovative and different. FX as an industry is very good at tweaking things. I don’t think it’s because there’s an inability to innovate or a lack of intelligent people, it’s just perhaps that there hasn’t been a need, it’s not broken and the incremental technology improvements being made are exactly what the market requires,” he says.

So, yes, the heady days when e-commerce was just taking off – and the level of creativity associated with that – are over. And yes, the pace of innovation at banks has slowed, meaning that the industry increasingly has to look elsewhere for new tools, technologies and services. But this doesn’t mean that innovation is dead in FX, but rather that as a much more mature industry than it was 20 years ago, this innovation will occur in more incremental steps.

As Sigelbaum puts it: “In FX, in order to change anything you need to commit time or money, you have to ensure that you’re solving an existing problem, and then once you’ve completed one, you can start working on the next one, and so on and so forth. You need to have a path of small wins to get to the endgame, but you can only get there block-by-block, otherwise people won’t prioritise it, because there are too many competing efforts going on within organisations. But if you make consistent, incremental changes then all of a sudden you build momentum and there is a path towards change. Some companies out there are doing this,” she says.

Galen Stops

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