(FX) Breaking Up is Costly – If You’re in Bed with the Wrong Partner

Monogamy is costly, at least when it comes to FX derivatives markets – that is the conclusion of a working paper from the Bank of England that looks at the impact of the collapse of Credit Suisse through the prism of pricing to clients associated with the bank.

This is because while relationships are a core feature of foreign exchange markets, just like in other areas of life, breakups are expensive. The new working paper from the BoE shows that clients with strong ties to Credit Suisse paid 16 basis points more per notional dollar for trading in OTC derivatives markets when the Swiss bank imploded than those that had little or no relationships with the now-defunct dealer.

The paper, The value of trading relationships in FX derivatives: evidence from Credit Suisse’s collapse, highlights the downside of relationship pricing at times of stress and shows the flipside of these long-term arrangements.

While FX derivatives are one of the largest markets in the world with a wide variety of participants accessing prices, the paper observes that the latest BIS figures show that only 6.8% of outright forward and swap trades are centrally cleared. This leaves $67.88 trillion of notional traded and cleared bilaterally (as of the second half of 2024). 

While there is plenty of anecdotal evidence for the impact of relationship trading, the paper authored by Gerardo Ferrara and Helene Hall provides new insights into the effect of this market structure during times of stress – and the evidence from the March 2023 event shows that breakups are costly.

“Our analysis reveals that clients with greater exposure to Credit Suisse experienced a larger increase in spreads at the client level relative to unexposed clients by about 16 basis points per notional dollar traded on average across maturities, although their trading activity remained unchanged,” the paper states.

Spread increases affected clients that previously relied heavily on having a tight relationship with Credit Suisse as they paid the price once the dealer withdrew from markets. “The greater spread increases paid by clients who relied more heavily on Credit Suisse occurred through their trades with non-Credit Suisse dealers,” the paper says.

The heaviest price was paid by those that found it difficult to find new counterparties: those that were able to reduce their trading activity with the struggling Swiss bank rushed to do so and sent trades to other banks.

How clients are able to navigate scenarios of market stress is directly linked to their trading behaviours in normal times, the paper finds. Those that diversify their counterparties were able to switch to different dealers more easily than clients who had very tight links with Credit Suisse.

The BoE found that persistent trading relationships mean that clients are 32% more likely to trade with the same dealer if they’d had tight links in the previous four weeks. “Our analyses confirm that clients pay higher average spreads at dealers that compose a larger share of the client’s trading portfolio, consistent with dealers charging larger markups to clients that search less intensely,” the paper concludes.