The Last Look…
Posted by Colin Lambert. Last updated: March 8, 2021
One of the lasting legacies of the pandemic, in FX terms at least, is likely to be market structure change. Talking to people in the industry I get the sense that everything is up for grabs and that previously sacrosanct entities and processes are facing if not unprecedented competition, then a buying audience more open to thinking the unthinkable.
The industry is moving out of the business continuity phase prompted by COVID-19 and is back where it was actually likely to have gone if 2020 had played out as planned – the innovation stage.
Take the following potted, and deliberately chosen, timeline in the FX industry. The early 1970s saw the floating of currencies and the birth of the modern FX market. The early 1980s saw Reuters Dealing change how we connected with each other and made the FX market a truly global entity, before the early 1990s took that further with the launch of first Reuters Matching and then EBS, to replace the voice brokers in spot.
The turn of the century saw the multi-dealer platforms transform the client FX experience, before the early years of the last decade saw aggregation start its journey to what many believe is the dominant position in the market.
My point is, clearly, that there is a close to a 10-year cycle of innovation in the FX market structure, possibly because that is how long it takes good ideas to really take hold, possibly because it is a cautious, slow-moving beast. Either way, the calendar is in a new decade and history suggests something will change.
The past decade has been dominated by technology and technological innovation, but in that period one could have made this argument credibly, but without confidence – there simply wasn’t the will to “buy in” on the part of key players. That is now changing, from the buy side looking at how they interact with the market, to a shrinking FX banking sector that is, for the most part and with a few honourable exceptions, focused more on being agents than principals.
Perhaps more prosaically, there is a new generation of managers in the banking industry that realise they have advantages over challenger firms, but that they are gently being eroded. Existing senior managers have also had their collective mind focused by the pandemic, which highlighted just how much we, as an industry as well as a society, rely upon technology. So technology has to be maintained and be state of the art – institutions rarely tolerate their trading and sales people falling behind, why should they let their tech do exactly that?
Hearts and minds – and eyes – are being opened to the need for change, and that means a challenge culture, not just within the firm, but also within existing external relationships. Service providers want their offering to be if not the fastest, then close enough to the fastest, and that means they will seek solutions elsewhere if necessary.
This change cannot come soon enough in some areas. I observed on a call with someone last week that it is five years and counting – probably more in reality – since I started hearing “credit is a bottleneck”, but in spite of solutions existing, the industry hasn’t actually moved on that quickly, if at all. Through compression, novation, connectivity and data throughput, however, it can be solved easily, and using technology that exists today (and before this becomes a commercial for certain businesses, let me state that the opportunity still exists for challengers in this space – after all, no one has managed to move to a dominant position in the last five years!)
Equally, people have been complaining about the pace of settlement in FX markets for more than a decade, and while CLS has no doubt made it safer, has this part of the trade process actually been enhanced in the interim? Again, solutions exist – and ledger technology comes to mind – so why are they not being adopted?
The answer in the recent past has been closed minds, too many vested interests trying to preserve their position, but that mindset is, I sense, changing very gradually, and people are more open to reconsidering what are, in many cases, cemented in processes and infrastructure.
My aforementioned innovation cycle has historically focused on the trading process and while I think more will happen either side of the trade, it is highly unlikely that trading itself will escape unscathed, but what will it look like?
Speed is often associated with largely unpopular trading practices, but the fact is the quicker the underlying technology can become, the more efficient the market is likely to be. It does not have to mean allowing people to trade in microseconds, MQLs and latency floors have their place, but it can mean that when people trade, the whole process, from credit checking or allocation, through execution to settlement, can be more efficient and quicker.
The question is, how many firms in the FX platform market are either open to the right level of collaboration with a fintech, or can move quickly enough or compete with newer firms? I accept that footprint remains important, but ask a banker – customers have proven quite demanding and willing to move providers if they think the tech on offer isn’t good enough – footprints can be washed away. The unthinkable can happen, and in this case it is the fall from “power” of some of the bigger spot venues.
How many firms in the FX platform market are either open to the right level of collaboration with a fintech, or can move quickly enough or compete with newer firms?
There are those that argue that we have heard these predictions before and that the “majors” retain their position – but do they? In terms of price formation absolutely, but when it comes to actually trading? That is less clear. I have written before that a lot of the numbers in the platform world, especially from the older platforms, have been declining not only in notional terms but, more importantly, in terms of their share of overall activity.
A quick look at the BIS Triennial Surveys indicates that the four platforms to have been reporting data across the past four surveys have seen their share shrink dramatically. In 2010, the four (EBS, Reuters, CME and Hotspot) had a 28.2% share of spot business. Three years later, this share was down to 19.5%, and by 2016 it was at 17%.
In the latest survey in 2019, the same four venues were responsible for 12.7% of turnover – that’s how much it has changed. I should stress, this is not to pick on those four venues, Hotspot/CboeFX almost doubled its ADV from 2010 to 2019, merely it is a reflection they are the only public data points we have. Add in the other venues to have started reporting in 2016 and the share of all the spot platforms’ ADV was 15.1% of the BIS number in 2019, down from 18.8% in 2016.
So, yes, we have heard these arguments before, but the big difference this time is a new, more open-minded audience is listening – one that does not have the emotional connections to the venues that their predecessors did, and one that looks at the hard data of the value, and cost, of the business. This does not necessarily mean the end of the road for the incumbents, more it is a warning that infrastructure upgrade has to be accelerated if the decline is not to itself speed up. A solid global footprint should not be underestimated, but it may not be the saviour it once was. The challenge for a lot of people over the coming months, therefore, may well be very different from before, because rather than fight the change, this time they not only have to embrace it, but keep up.
Some platforms and their (often newish) owners will no doubt respond well to this, but those who think they can rest on their laurels may want to consider the banking industry, where we have seen quite radical change over the past five years. As noted earlier, more and more are embracing the agency at the expense of the principal and they are doing this because they found the pace of change necessary to keep up with rising challenger firms was too onerous and too expensive.
To many in this sector, the solution was to effectively wave the white flag and change the model – even if it was to a brokerage model that is fated to end badly. The investment required simply wasn’t worth it and that is food for thought for incumbents who have fallen too far behind in the technology stakes. Their solution has to be either a serious investment programme (unlikely), or the getting out of the chequebook to buy a collaboration (or a firm) that can get them in the game.
They have to do this because Change is coming. It may not be this year, but the arguments are becoming more compelling – not least because, as noted, we’re due!