The Last Look…

If anyone was wondering why there is so much emphasis on payment-versus-payment in FX markets amongst regulators, they need only look at the events of the past week.

In spite of some institutions apparently deciding it wasn’t a priority to have a chief risk officer – and that is a criminal, rather than functional, failure in my mind – several firms that I have spoken to had people in critical positions who were about, and learned lessons from, the events post-2007. This meant that the response to Credit Suisse’s travails, while still quite varied, enabled the markets to function.

We also learned a new lesson, the dominance of non-bank market makers in certain liquidity pools has changed the dynamic. Multiple sources tell me that several non-banks were very quick to abandon all trading with Credit Suisse on those public platforms they engaged on, something that might have been challenging for the AES agency execution business of the bank, which offers several strategies that rely upon external liquidity. The banks themselves were a little different, with one or two taking the same path but then reversing their decision, and the others taking the sensible risk management path that has been created by the industry for just such an event – the use of RFQ in CLS currencies.

CLS, as I have noted before, is not a panacea of course, and Credit Suisse was struggling I am told in non-CLS currencies, which is a challenge because as multiple surveys have shown over the past decade, EM investment and trading volumes are rising quickly. The majority of flow is CLS-eligible, however, which meant the market could continue to function and Credit Suisse was not cut off like a pariah and had access to (admittedly reduced) liquidity.

One non-bank source told me they thought the cutting off of lines by that sector was purely a CLS-related matter, although their prime brokers clearly have access, so I am not sure why that is the case. Perhaps it is one of control, in that they would not know whether the PB industry would build too big a position with Credit Suisse, a la Archegos?

I cannot stress enough that the work is ongoing to solve this issue, but equally how important it is that the pace of development increases

Either way, with UBS, or the Swiss government – take your pick – buying Credit Suisse, hopefully puts the problem is behind us, although I would caution that while everyone associates the GFC with the collapse of Lehman Brothers, JP Morgan “rescued” Bear Stearns the year before in similar circumstances (with government ‘encouragement’ rather than backing if I recall correctly).

If this is the case, then this leaves the FX industry with one major question: What is it going to do to fill the “CLS gap”?

I have written on this subject before and noted that of several challengers in the market Baton Systems seems to be at the head of the pack with its PvP solution, surely now the industry has to get behind this, or one of the other solutions to help reinforce the vital service provided by CLS? Of course, the industry may decide it wants CLS to cover more, but as I wrote last year, this is not just a matter of pressing a button and the magic starts to happen – and that is a challenge facing anyone who seeks to fill the gap, not just CLS.

Whichever route is taken, and allowing for the fact that the events at Credit Suisse are about more than FX – if indeed the FX business was a problem at all, which I doubt, the industry has had a warning similar to that in 2007. In 2008, when it was really needed, CLS did what it was designed to do and enabled the smooth(ish) functioning of the FX market through a very turbulent period, the big question the FX industry should be asking itself now is: How do we extend these PvP benefits to a broader spectrum of currencies and users?

How it responds to that question is vital to the ongoing health of the FX market, there are initiatives in place, they should all now receive the boost they need to get them to the mainstream, for it is clear that PvP, alongside RFQ, is a good solution to help the market function effectively.

I’ll close with some data. In 2010, as the global banking bail out was in full swing, average daily turnover in emerging market currencies was $387 billion. In 2022, it was over $1 trillion per day. Those numbers reflect the scale of the challenge, and also why the Bank for International Settlements’ highlighted the problem in 2019.

I cannot stress enough that the work is ongoing to solve this issue, but equally how important it is that the pace of development increases.

colin@thefullfx.com