Does UBS Buy of Credit Suisse Hamper FX Market Liquidity?

UBS has agreed to buy Credit Suisse in a move to shore up the global banking system as much as Switzerland’s, but what does the effective removal of a Global Systemically Important Bank (GSIB) mean for the functioning of the FX market?

The kneejerk reaction as the UBS deal was announced was that a chunk of liquidity is going to disappear from the market given the bank’s public statement that Credit Suisse’s Markets business will be moved to “non-core”, i.e. dispensed with or closed down. Given the troubled recent years at the bank, it is hard to believe that a buyer will be found for CS’ Markets business on its own, therefore a major player is likely to disappear from our market.

This has happened before of course, there were a series of major bank mergers either side of the turn of the century that took out some very famous FX names like Chase Manhattan, Chemical Bank, Bankers Trust, Midland Bank and Swiss Bank Corporation to name just a handful, and, allied with the introduction of the euro, volumes did diminish, but they bounced back as new players entered the market – most notably the non-bank players.

There are a couple of crucial areas where most non-bank players cannot take up the slack, however; with certain client groups, and in the forwards market. For the first, asset managers are more open to whom they deal with, but the non-banks are simply not streaming in sufficient size, and certainly don’t have the large risk transfer appetite that is sometimes demanded by asset managers. They can certainly handle the day-to-day flow, but in volatile markets, there is more propensity to just get out of the risk on the part of the buy side than to “finesse” it out.

The credit conundrum, that has hampered markets for so long now, is also unlikely to help non-bank firms pick up any slack from CS in the forwards market, although naturally, given the troubles at the bank, it has been less significant in these markets in recent months according to sources. Prime brokers are learning the SA-CCR lesson in non-spot products, and are therefore likely to be less than helpful assisting non-banks into the forwards market, and clearing initiatives are still some way off.

So, if non-banks may not be picking up the slack, who else can? There are clearly a group of regional or specialist banks that have strong balance sheets, but few have the risk appetite to step up in the forwards market, and also in spot are struggling under the sheer cost of doing business on some platforms given the constant pressure on margins. Another factor for some of these firms is their relative lack of technological presence – they may have rudimentary single dealer platforms, and/or the ability to stream good prices, but will it be at the same level as CS? It’s unlikely, and even if they do, they are likely, as the BIS found in a working paper back in 2020, to be pricing wider.

An interesting aspect of the post-merger is the fate of Credit Suisse’s AES business. UBS has its own agency execution business across fixed income and equities, but while it has an FX algo execution business it is perhaps not as synonymous with the strategy as AES is/was. For several years, AES in FX continued to do really well in spite of word on the street being it was one of the more expensive offerings. This is partly the result of a well-built product, but also of customer inertia, for while the initial AES in FX was indeed ground-breaking in many ways, it also suffered a period of under-investment in following years.

If liquidity is not to be diluted somewhat following this event, then concentration risk will increase, and this perhaps provide an opportunity for one idea that is gaining more popularity – peer-to-peer.

The competitive landscape in FX algos, indeed algos generally, is such that the value of AES to a prospective buyer is diminished, but there is still the factor of what seems to have been a loyal and valuable client base. It is feasible that a bank may look at AES and see a valuable client book to introduce to their own algo suite, but that again ignores the problem of clients being moved from a familiar environment – a time at which they are more vulnerable than ever to a “tap up” from a competitor!

Ultimately, a bank looking to go multi-asset class with its algo execution offering may be interested in AES, but it is likely to be a hard sell if not for the sole reason that when it comes to algos, there is plenty of choice already out there.

To go back to markets more broadly, it is likely to disappearance of Credit Suisse will be felt in pockets of the market, rather than across the board. The unwinding of positions will take millions of work hours no doubt and removing a significant player from the markets smoothly, will take a lot of time and resources.

In forwards, liquidity may be affected and spreads may widen slightly, purely because a G-SIB has disappeared. In spot it may also be felt, but it is likely to be less impactful due to the sheer breadth of execution solutions open to buy side firms. That said, there are going to be firms who dealt with CS almost exclusively, or as part of a small group of liquidity providers, that will now be searching for a gap-filler.

If liquidity is not to be diluted somewhat following this event, then concentration risk will increase, and this perhaps provide an opportunity for one idea that is gaining more popularity – peer-to-peer.

If the buy side is concerned about a concentrated counterparty pool and the loss of a major bank LP, are they going to look even closer at the peer-to-peer model? It would certainly seem to make sense to explore the avenue, although it is hard to see one major obstacle disappearing – that of an “on-demand” two-way streaming price. The buy side may well wish to deal with each other more post-CS, but will they be willing to assume risk, rather than just dispense of it? That is very doubtful.