It’s a valid question to ask FXPBs what constitutes a “good” client these days. Post-Basel III, firms taking big positions in non-spot products are going to consume vastly more balance sheet and capital than a firm trading only spot in smaller amounts, which can easily be serviced with a relatively little net open position (NOP).
This obviously suggests that, for example, an HFT deploying a spot-only strategy could potentially be a more attractive business proposition than a large macro fund trading longdated NDFs or options products.
However, speaking to a number of FXPBs, it immediately becomes apparent that such a view is too simplistic. One FXPB head says that this basic analysis is correct, but only assuming a legacy pricing model, which is derived primarily by frequency and size of transaction activity. The
FXPB head adds that they can’t see any reason for this legacy pricing model to continue in the future, stating that if a client that wants to transact with less frequency but taking large directional positions, which tend to be demanding in terms of capital and balance sheet requirement, there’s no reason why a client like that can’t be attractive – it’s just that the pricing model needs to be different.
Likewise, Marcus Butt, head of FX prime services at NatWest Markets, comments: “The cost of these things is different. As long as your client is meeting their hurdles, then it doesn’t matter what type of trading they do. The operational risk and the credit risk with HFT businesses are very different compared to a macro client.
He continues: “If you have a client and they put on a big trade, then from a capital point of view you can collateralise the client potential exposure, and if you can compress the trade against the dealer, then both cost elements can be managed. The spot business doesn’t incur capital costs and so is the most efficient and, as such, it is also the most keenly priced.
“Most of our clients are aware how capital charges are applied, how it impacts our business and the consequential costs of that,” Butt adds. “I think that people are generally very rational when you talk to them about the cost of different types of business. The key thing here is that if people’s business models change and their activity changes, the cost impact of that business could change, and so we monitor that on a regular basis.”
Russell LaScala, co-head of FX at Deutsche Bank, says that Basel III represents “just a new flavour of capital requirements” and that, while balance sheet impact has always been a consideration for the bank, “it solely does not determine what constitutes a valuable client relationship”.
He adds: “How and what they trade is just as important. We take a holistic approach to clients and have the capacity to service both high volume vanilla clients, as well as clients who require derivatives products.”
Banks certainly take a holistic view of their customers in terms of the business they do across the whole bank, with numerous FXPBs stating that a hedge fund or asset manager might be more profitable overall for their institution in terms of pure returns, while an HFT or a spot-only market maker might be more profitable on a pure FXPB basis. The key, the FXPBs stress, is to create a balanced ecosystem that has a range of different types of trading firms within it.
“What I strive to do is for every large macro fund that I bring on to the platform that I know is going to consume meaningful balance sheet, I’ll try and bring on two or three professional trading groups or market makers that actively execute offsetting spot transactions throughout the day,” says John O’Hara, global head of FXPB and FX clearing, at Societe Generale. “With a relatively nascent offering I can manage the account roster at a granular level, ensuring that scarce resources are being maximised without diluting the requisite benefits of the offering. Effectively marrying large consumers of balance sheet with those whose impact is more benign. It also helps that the large global macro firms on the FXPB pad are also availing themselves of our futures, fixed income and OTC derivatives clearing services,”
One former FXPB professional says that the longevity of a client is an important factor, and this is why they were always wary of firms that haggled extensively over fees. “Anyone who haggles on nickels and dimes up front is not the type of customer that you want, what you want is a firm that comes in for the business model because it makes sense in the long term. If you have someone arguing over three, four, five cents a million straight away, then tell him to take a hike – because that business model is not sustainable in the long
term,” the former FXPB professional says.
Similarly, O’Hara comments: “You have to price the business thoughtfully and be transparent with the client regarding your rationale for same. It is important that our customers are cognisant of the impact of their trading style in our new regulatory environment and why it has been priced a certain way. I can tell you that most of the clients that I speak with value longevity over paying slightly more for the service, and certainly post-SNB the savvier players have a new appreciation with that line of thinking. There are still a few firms that can command certain pricing concessions, which haven’t given much thought to the impact of Basel III, etc, and continue to push providers to the lowest possible price. Fortunately, I think that there’s enough business out there for my team to pursue without having to entertain those types of accounts.”