The Last Look…

Customers like to moan…FX dealers like to moan…let’s face it, everybody likes a good moan every now and again! Which brings me to an interesting situation whereby everybody seems to be moaning about something around a central theme – conditions in the FX business.

A few buy side players have raised concerns recently over their liquidity. Conversely, some on the sell side are talking about how difficult it is to make money out of FX – the market is so commoditised. Both are, naturally, fairly blinkered views, they also are very spot-focused, whereas in my position as a “big picture” person I acknowledge other markets do exist…sometimes.

Looking at the spot market, and concerns around access to liquidity, to a degree this is nothing new. JP Morgan has been running surveys for several years now where it looks at trends in client thinking and access to liquidity is nearly always at the top of their concerns (it was second this year, but to volatility, which is kind of linked). More recently, however, a few people have been expressing fears over liquidity levels as certain players’ interest in the market wanes.

There is a connection with the concerns on the sell side, where people don’t think they’re making enough money, even though there is still some volatility, albeit not on the scale of last year. Both worries are driven by firms pulling back because they either don’t want to spend money on the tech arms race; can’t make enough money even if they do; or don’t see the point of a white labelling agreement.

There is an argument that states spot FX has become too efficient for its own good – the growth in systematic strategies and algo use on the buy side has made it tougher for the sell side to make money, or add value. Equally, that sell side is becoming even more defined by buckets, wherein the top group of internalisers are largely streaming the same price, the second tier pop their head up every now and again; and those below there, focus on their domestic customers and offer little in the way of competition in the wider market.

We have gone through a period of juniorisation, allied to a growing reliance upon technology – neither is particularly conducive to higher risk

This could be seen as just the next stage of evolution – the FX market used to be very inefficient (in favour of the banks), then the non-bank community disrupted things, first by being arbitrageurs, then by turning their hand to market making, and more recently, regulatory change has seen the risk appetite on bank desks largely disappear. I have said before and I will say it again no doubt – the average bank spot FX business looks very much like the old voice-broking model from the last century – get the flow in and match it off for a small fee (spread).

The challenge facing the industry now is that not only have several respected banks reduced their commitment to FX, but the firms that drove that – the non-bank market makers – are themselves looking at FX and wondering, ‘why are we so involved?’ I have had people from four non-bank firms tell me that their models can make between five and 10 times more in equities for example, as they can in FX – the latter is just too efficient and margins continue to be squeezed even as oversight and technology costs continue to soar.

Things could get worse if the latest crypto boom is actually sustained (the jury is still out I think), because that will attract assets and technology budgets. Crypto still has spreads, market makers will chase them (and, in time, eradicate them).

Another problem is that banks’ risk profiles are severely diminished. To a degree the buy side concerns about this are based upon cherry picking – they want to put LPs in competition, but retain the ability to trade on a direct basis if the smelly stuff hits the fan. Some are able to do this, an increasing number it seems, are not.

I also think that too many banks are slow to adjust their models – we have seen a dominant trend in the dollar bull run, and we are seeing more micro trends within the market, but these don’t suit the internaliser/broker model. There needs to be a more nuanced approach to risk management in my view, where certain flow is put on the book, and left there. I do, of course, look forward to people recounting their conversations with the risk function as they try to convince them of the value of such an approach…

To many in the trading (and sales) function, the current market environment is somewhat alien it seems – it doesn’t fit the low vol models that succeeded in the middle of the last decade, but it doesn’t really suit a trending environment. This is part of evolution, of course, but I think a factor is the lack of lateral thinking among the principal players in the industry. We have gone through a period of juniorisation, allied to a growing reliance upon technology – neither is particularly conducive to higher risk. It will change, but just not at the moment, and that, perhaps, is why a growing number of people feel uneasy.

Personally, I think there are enough people making good money in FX to sustain a business – the problem is they are either stuck in that Management 101 cycle where inexperienced or robotic bosses just up the targets every year come what may; or they are judging themselves on what was a pretty good 2022.

I don’t doubt things are tougher – the last year or so has seen an increased regulatory burden and I have no doubt that expectations were raised thanks to 2022 – but are they much tougher?

I tend to look at the public platforms as a barometer of how the industry is going – they are a fraction of overall volume, but a useful bellwether – and the big picture is that the first nine months of 2023 are pretty similar to the same period in 2022. I noted in a report earlier that EBS and CME’s futures volumes are down on the same period in 2022, but elsewhere the picture isn’t so obvious. FXSpotStream and Euronext FX are slightly lower over the first nine months compared to the same period in 2022 (by some 2% and 5.8% respectively, but 360T (+2.7%) and Cboe FX (+7%) are both higher.

As I also noted in my earlier report; for some strange reason – and the third time in the past year – LSEG has fallen behind in its reporting and has yet to publish September data, but it is notable that in EBS, Cboe FX and Euronext FX you have varying fortunes for what are ostensibly the same model. Likewise with 360T and FXSpotStream.

This tells me that conditions are confused, but in the big picture, they haven’t changed – perhaps the market has gone back to sporadic volatility, but it is so on a more regular basis. It is hard to discern how things are going in such an environment, and clearly I am not the only one pondering this question.

The problem is, it seems few of us know the answer, in which case we revert to human nature – and complain! I don’t doubt things are tougher – the last year or so has seen an increased regulatory burden and I have no doubt that expectations were raised thanks to 2022 – but are they much tougher? That isn’t obvious to me. Perhaps we need to re-assess the industry’s approach to risk and how we judge it – after all, it is risk takers that make the world go round.

The world doesn’t seem to have changed that much, but our expectations as an industry have – and they have gone in a different direction.

colin@thefullfx.com