The Last Look…
Posted by Colin Lambert. Last updated: July 25, 2023
There was a time when it was assumed that a decent corporate franchise was the backbone of an FX business – generally the flow is relatively benign and therefore delivers some decent value in the form of P&L to the trading business. Over the past two decades or more, hedge funds, and then asset managers because more popular, although the corporate franchise did continue to deliver. Recently, though, I have had a couple of conversations with people who feel the value from this segment is diminishing.
It is, from an outside perspective, an interesting approach on the part of one of my conversants, bemoaning an institution’s inability to monetise its corporate franchise in the way it used to,. My first response was that this says more about the institution’s risk management processes than it does perhaps the value of the flow itself. It seemed to me that the corporate flow wasn’t being held, rather it was being treated by the institution in question in the same fashion as that from other sources.
Obviously, my conversant couldn’t go into that much detail, but the suggestion was that there was an element of truth in that view, however there were other factors at play. Specifically I was told – and I have heard this more in recent years – that more corporates seem to be engaged with TCA than before. Other have also noted that the recent banking wobbles were prompting treasuries to broaden the number of counterparties they engage with, thus competition was growing.
One of those factors seems irrelevant to me and the other a short-term phenomenon.
I say these firms’ use of TCA is irrelevant because all that practice judges is the effectiveness of the execution – in many cases, ‘did I hit the best bid or offer?’ My point about a lot of the corporate flow out there, is that it is not about the short-term mark-out, it is about the bigger picture – was the trade timed to take advantage of a market move? There is no doubt that some multinational treasuries are incredibly sophisticated and knowledgeable and therefore their trades are “informed”, but the vast majority of treasuries still view FX as an administrative hedge to be executed blindly at the time dictated.
Equally, the problems in the banking system may have woken a few treasurers up – there was a survey from MillTech FX saying just that last week – but the reality is the recent upheaval seems to be temporary. What actually happened was some poorly-managed banks went to the wall, it was not a systemic problem. Of course, knowing whether a counterparty has ‘good’ or ‘poor’ management is a hard judgement from outside!
I suspect the challenge for some players with the corporate space is the sheer breadth of sophistication therein. As noted, some treasuries can rival a good hedge fund for their abilities, but below that top echelon the needs of a treasury are both diverse, multi-lateral and, often, simple.
The corporate world will never be the superstars because the volumes aren’t there, but the value is
Historically, my experience with corporate treasuries has been they adhere very much to the KISS principle – the easier the process, the better. They have better things to do with their time than worry about an FX trade. This makes them, somehow, less attractive to their counterparts on the sales teams – after all, where’s the fun in a strip of forwards or a spot trade when you can sell the treasury a reverse knock-in, target redemption, butterfly, protective collar, strangle? (and yes, I know!)
This is the problem for some in the industry – the corporate world just does not fit their ideal image of a client. This is still a very conservative sector that embraces change reluctantly. More pertinently, volumes from this segment have been going down for some time – aside from the sharp drop in activity in 2016, corporate FX volumes are at their lowest since 2004 according to the Bank for International Settlements.
Yes, volumes have declined (aside from 2016, spot volume is at its lowest since 1992), but there is still a tremendous amount of alpha in it for the institution with the right approach – in other words, someone willing to actually carve out the risk and hold it, rather than use it for internalisation purposes. I accept that the existence of a good corporate franchise can help a player quote tighter elsewhere, but I wonder whether this is the right approach? Is it better to take a bit more of a hit elsewhere to retain the larger value from the corporate flow? Of course, another option would be to stop using the corporate flow as a backstop and quote slightly wider (and more realistic) spreads to other customers!
The corporate world will never be the superstars because the volumes aren’t there, but the value was, and is, there. I suspect what it will take for this flow to become more appreciated is, perhaps, greater that competition I wrote of, but then that itself introduces the complexity of corporates’ demands for a wider relationship than just FX trading, so may never actually happen.
Ultimately, the problem for the corporate world is in the numbers that still count too much to certain players – the volumes. There are still firms obsessed with market share to the possible detriment of the bottom line – just a few weeks ago an e-trader told me they had an “expensive” client they had to quote “because we want to know what they [the client] are doing’. This is a 1980s attitude and doubly ironic because even if the firm in question does find out what the client is doing, they will, unlike the 1980s and 90s use the information defensively to inform their quoting rather than taking a position!
There are banks in particular that have very strong corporate franchises, and their FX business seems to do very nicely – I am sure the two factors are related! Perhaps what is needed from elsewhere in the markets is a better understanding that a lot of the corporate world’s flow needs to be treated differently.
Yes, there are complexities in having the relationship, and yes, sometimes the flow can be difficult to monetise, but ultimately, if looked at through the prism of the treasury itself – it is still an admin trade even at the biggest companies – a different approach would bring much greater benefits.
