Dynamic Credit Gets Scaled
Posted by Colin Lambert. Last updated: March 28, 2023
Following news that United Fintech following its acquisition of the business, is relaunching CobaltFX, Colin Lambert talks to United Fintech partner and COO Marc Levin, and Cobalt founder Andy Coyne, about plans for the relaunched business, and the impact it can have on the FX markets.
Colin Lambert: Marc, United Fintech bought Cobalt in December 2022, what has been the focus since then leading up to this re-launch?
Marc Levin: We have been speaking to Andy and Darren Coote about how the business fits into United Fintech, how the team will look and what the business should focus on. We want to pursue the original idea behind the business – hence the re-naming to CobaltFX – so we are spinning out the digital assets piece for a later initiative and focusing on dynamic credit in FX markets and post-trade optimisation.
We believe the CobaltFX solution is solving real industry problems and changing the FX market for the better, because while there has been a lot of investment in the front office, other areas of the FX business have been neglected. We think it is time to change that to ensure the infrastructure of the FX market is as robust and efficient as possible to keep up with front-office requirements as well as address systemic risks in the industry.
Andy, we have spoken several times about the need for more efficient use of credit in FX markets and there have been false dawns – in spite of it being in my mind a very good and important idea – what’s different now?
Andy Coyne: United Fintech has given us a platform that not only makes our lives easier because it is a bigger team, but potential customers can look at us differently as well. We are no longer a small company, this is a larger firm taking the credit issue in the industry very seriously and that gives us the scale to solve what remains a major bottleneck.
There is a higher degree of importance placed upon the problem at banks although there are still people who believe credit isn’t a problem, but that view is diminishing because a lot of banks out there are struggling on a day-to-day basis with credit allocation and optimisation..
Additionally, there is more concern being expressed by industry bodies and regulators, who see over- and under-allocation of credit as a systemic risk. The forwards market especially has been crying out for a solution like this, even more so since SA-CCR started to impact banks’ ability to trade in the market.
And that is really what the CobaltFX solution is about isn’t it? Improving market access through more efficient use of credit.
Yes, credit is very circular and it does affect trading, but people have forgotten this and they continue to use credit very poorly. It should be a facilitator to execution but cannot be unless it is used more efficiently and effectively.
It is about seeing more prices, deepening liquidity and moving exposure off the balance sheet that doesn’t need to be there. This makes the institution more efficient with its assets while at the same time providing its traders with better pricing trading opportunities.
To do this we need normalisation of nomenclature for example. If we are going to compress trades, optimise for credit and report trades there needs to be an element of utility, where everyone understands who they are dealing with and what their exposures are – and that is what CobaltFX does, it provides that golden copy that is the foundation of a more efficient process.
The market is inter-connected, but most people work in silos, so our single point of distribution solves for over- and under-allocation of credit and allows everyone to work with what they really want – a single global limit. This makes the banks – who after all are the credit owners – much more efficient and in control. Recent bank collapses make it even more important to have effective credit controls and processes in place to be able to respond swiftly and appropriately.
So this is very much about the timing – you are saying the market is ready for this whereas previously it may not have been sufficiently focused on the issue?
There’s no reason why it shouldn’t have been done by now, but not everyone has woken up to the impact inefficient credit management can have on a trading business’ bottom line. Most participants have been making money the last few years and there have been various external events, all of which have served to reduce the focus of credit optimisation.
You are right, other events conspired to slow everything down. In our experience though, two things really change adoption rates – customer or regulatory demand. We have partnered strategically with key banks to drive change, but probably the big driver currently is regulation – all assets have to be treated much more carefully than they were and credit processes need to be improved.
Demand is certainly growing, we are going live with one bank in April, with two others close behind using dynamic credit to manage credit across all their ECNs, and with the scale United Fintech offers us we can engage much quicker with a second echelon of banks that will also benefit from the solution and roll it out further. The reality of it is that we need a small number of banks to prove the concept and go live with it. They, as early adopters, will see some great benefits, but they will also encourage others and then benefit from the networking effect that ensues.
Can we talk specifically about the forwards market, because I see this as being very fertile soil for Cobalt FX. So much seems to be changing in this area, with greater automation and the hint that some FX swaps may be cleared in the relatively near future, this looks like a great opportunity for a dynamic credit provider.
Dynamic credit is very important for market access in spot markets, but the magnitude of its impact could be significantly higher in forwards where credit remains a serious bottleneck – and you’re right, there are other initiatives in play that are changing the forwards’ market structure.
As well as solving for over- and under-allocation, though, we can also sweep positions – optimisation is a key element of our service – to, for example, a clearing house. It makes perfect sense for the clearing house to step into an optimised trade to help clean up market access. Some get hung up about having collateral at the clearing house, but you are netting and collating positions there and the CCP is a better counterparty risk; the regulators love it as a model.
People think collateral is the only cost, but it’s the quality of the counterparty that is the real cost, a lot of strong balance sheets are owned by banks who don’t take much market risk, but there are others who want more market risk but can’t. By being more efficient in deploying their credit assets and managing them post-trade, for example, and by optimisation to clearing, we can collectively improve depth of liquidity and market functioning.
There is no reason anyone should say no to this concept, because there is a huge amount of upside and I can’t think of a single downside to it.
I think of all the things we talk about in markets at the moment, optimisation is one of the biggest things.
It is, but we are different. Optimisation providers very much act from a cross asset point of view, whereas we optimise for market access purposes. It’s not cross asset, just market access, which is why we think we are different. This is about profitability in the front office by keeping market access, through credit, as optimised as possible, and it’s in real time, not once a week or monthly runs.
Marc, can we talk about how specifically will United Fintech help to scale the CobaltFX business?
United Fintech comes with a broad distribution platform through our offices in London, New York and Singapore and we simplify certain aspects of running a business by centralising finance, legal, HR, marketing, et cetera, which frees up the CobaltFX team to focus product development, innovation and client satisfaction.
United Fintech is a decentralised business model at a product level, so CobaltFX will continue to operate independently. It is very important to us to retain and empower the entrepreneurship and innovative spirit that identified a very important – and current – industry issue and developed a solution.
CobaltFX is strategically important to us at United Fintech, because it provides core infrastructure for the banks, who are the clients we want to work with for the next many decades. This is why we are investing heavily in the business with myself [as CEO], Elizabeth [Missfeld, as COO] and Erik [Nordal as CTO] on a full-time basis to help scale it.
With that ability to scale Andy, what needs to happen next and what benefits will it bring the industry?
It’s really about changing how people think about credit. It’s an asset, and that asset is owned by the banks – they own the risk. I think there is a degree of muscle memory around how we handle credit that is less than helpful in the current environment.
We are trying to put the banks back in control of their credit, and how they calculate it. The venues do a great job of facilitating execution but credit engines are not their core competency. They calculate credit usage locally, which fragments it and makes it much less efficient, given how the banks really want a single view of their exposures. That is what we do. We create a level playing field for credit for both venues and participants.
There is growing awareness of the inefficiencies around how credit is handled and of the benefits of the clearing house – especially in forwards. By optimising and centralising credit, banks can regain control of a vitally important asset and help their FX trading businesses run even more effectively.