The announcement by BNY Mellon this week that it is launching an FX prime brokerage (FXPB) service is interesting for a couple of reasons.
Superficially, it bucks a trend that has developed in recent years of banks scaling back, or even shutting down, their FXPB businesses. However, Profit & Loss already argued in a special report looking at prime services published in Q3 2017, that this trend was beginning to reverse itself.
So perhaps more significant is that it indicates that the barriers to entry in FXPB have been lowered as the cost of technology and infrastructure has both decreased and become more available.
“Having spent nearly 10 years running a large FXPB business you become very educated about how that business could be more efficient. So we’re benefitting from that experience, but also from being able to work with some fantastic fintech firms that provide high value, high return, but low cost solutions to our operating environment,” Michael Cooper, head of FX prime brokerage at BNY Mellon in London, tells Profit & Loss.
Not only that, but this service is coming to market post-Basel III, when the economics of FXPB have become more transparent and the fees that clients are willing to pay for the service have normalised to a degree, having previously being depressed by competition. Of course, it’s worth remembering that even though the barriers to entry have come down, this doesn’t necessarily mean that the barriers to success have as well.
It’s also worth looking at the drivers behind this launch.
“More than anything, we identified an opportunity and service need for our clients: to help them continue to navigate a demanding regulatory agenda. That theme has developed from regulatory compliance into what we think is a new phase: how do you now optimise your operating environment given that you’ve already complied with the regulations?” says Jason Vitale, COO, FX and head of client execution services, at BNY Mellon Markets in New York.
It might not sound particularly exciting or sexy, but in a world where firms are increasingly going to be subject to regulatory requirements forcing them to post initial margin and variation margin with bilateral counterparties, how collateral is sourced, managed and deployed will become an important concern. This is why, as noted in the special report, real money clients are increasingly looking towards FXPB services.
As a result, BNY Mellon is hoping to leverage its position as a custodian bank. In its current role, BNY Mellon already holds a vast amount of assets used for capital funding and cash management on behalf of its clients. And traditionally, custodian banks have been strong in the area of post-trade service and operations, meaning that BNY Mellon already has a range of tools and services designed to help clients manage capital or margin their assets in an effective way.
Hence Vitale, explaining why BNY Mellon is launching an FXPB service, comments: “One of the drivers is the uncleared margin rules which require sizable portions of a client’s portfolio to be collateralised with their trading counterparties. Also, a substantial portion of clients in scope have never had to post assets to a counterparty before. We have some unique products as a firm which help address some of the stress clients have endured – most notably our Margin Direct and Liquidity Direct products which help clients manage their collateral exposures across the street, which is also helping them optimise their cash management needs.”
He adds: “We also go one step further by offering yield enhancing products, mainly in the liquidity and cash management areas, that can help clients take passive assets and pick up additional yield. All of this is built on a strong FX franchise, with a strong credit rating and on a robust FX platform. That’s the competitive advantage, which we believe will help and address a need for a sizable portion of the market.”
Vitale is quick to highlight that BNY Mellon is not just targeting the real money community with its FXPB offering, but clearly this is the segment where, as a custodian bank, BNY Mellon might have more of a competitive advantage compared to the investment banks targeting these clients.
A final point of interest is how this FXPB service will fit into BNY Mellon’s overall FX business.
Starting with the appointment of Michelle Neal as president of the bank’s Markets Group in 2015, BNY Mellon has been scooping up senior talent in the FX industry, indicating its ambitions in the space.
During this time, the bank has also been on a drive to modernise, customise and broaden the suite of FX-related services that it offers to clients, which is where the FXPB offering comes in.
FXPB businesses don’t just exist to generate fees, they make clients stickier and attract more business for other parts of the FX franchise, most notably the execution desk. Some sources have expressed scepticism about the potential for custodian banks to build up sizable FXPB businesses for precisely this reason – they argue that these banks don’t have a large enough FX franchise or FX execution business needed to maximise the value proposition of FXPB for clients.
This is an argument that, unsurprisingly, receives pushback from staff at BNY Mellon, who staunchly defend the bank’s FX franchise. However, they concede that there were some holes in its FX service provision – namely on the e-trading side, which sits within Vitale’s purview as part of the client execution services division – prior to the recent investment into the FX franchise.
The FXPB platform will be one of the products within client execution services, and is being thought of as an important foundation for additional services due to be launched in the coming year. In this case, FXPB is not being viewed as a standalone business based on revenue, but part of a broader strategy to widen the services and tools that the bank can offer its clients.
The hope then appears to be that a symbiotic relationship will develop between this new FXPB service and the e-trading capabilities that the bank has been investing in on the FX side, whereby each will feed business into the other.
In case it’s not already clear, it’s worth pointing out that BNY Mellon isn’t looking to compete in scale with the very largest FXPB providers in the FX industry, but rather is seeking to use FXPB as a means of building out its own broader FX offering, with both existing and new clients.
Currently, the bank’s FXPB platform is in production although live, with clients due to be going live on it over the next quarter.