FX in flux

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The participants

Peter Billington, Head of FX trading, Commerzbank

Paul Scott, Head of eFX, Commerzbank

Gerald Dannhaeuser, Head of FX sales, Commerzbank

Peter Billington, Head of FX trading

The FX markets have been very resilient to the downturn. Why?

Anyone who has an export or an import business has exposure to foreign exchange. Anyone that deals in a commodity such as oil, which is denominated in dollars, will have an exposure to foreign exchange. So the market itself is huge with a turnover of more than $3000bn a day. That appetite for the market simply can't disappear overnight. If you look at the FX market, it's such a broad spectrum of users now from retail customers, corporate customers, all the way through to the sophisticated hedge funds. You have a huge palette of options for people to trade.

Has competition stepped up to a new level?

What the crisis meant was that people had to have a look at their business and reassess it. There's been a huge investment in IT and risk-management infrastructure, both front office and back office, to make sure that banks are capable of handling the risks they take on.

As your client base changes, will many new demands have to be accommodated?

That is one of the great benefits of FX. Having such a wide customer sweep and product range means that it's not beholden to one area should the liquidity dry up.

What impact is high frequency having on the structure of the market?

High-frequency trading was very much driven by the hedge funds and their demand for the instant access to the market. The banks had to invest heavily in terms of IT infrastructure for the sheer volumes involved and, in terms of people, the intellectual property to make the infrastructure happen. The benefits for the bank were obvious in terms of reducing transaction costs, reducing errors, access to the market and being able to distribute their products. The great situation for the clients is that they have access to the market, price transparency, the spreads have reduced, and they have access to a wider range of products as well.

What longer-term trends are you noticing on the trading side?

Going forward, I very much perceive FX as a service, not a price. A price can mean so many things but for our customers, there can be so much more in terms of the advice around the trade, the entry point of the trade, the suitability of the product and how the hedge performs over the lifetime.

Is it harder to meet the needs of such a diverse client base?

No. With the advent of more technology, there's less manual labour involved in writing tickets [and] booking trades. This allows the individuals in the business to actually spend time and impart that information to the customers, which is where they find the value and where we can really work together.

Are we going to see more trading in emerging markets' currencies now?

Undoubtedly. With the spreads contracting in the major currencies such as euro-dollar, people will look for opportunities to expand out into other markets. Banks that have a strong local-market presence will actively look to become experts and gain market share.

Is regulation one of the biggest issues for the market?

What [banks] need to have is the ability to react quickly to these regulations. They have to have knowledge in the business and the flexibility to react and adapt [their] systems.

What will differentiate the winners and the losers?

The banks that will succeed in the future will be the ones that are flexible enough and quick enough to adapt to the changing landscape.

Paul Scott, Head of eFX

In what way has technology transformed your business?

With the advent of algorithmic trading, the capacity of your [eFX] system has to have evolved. Twelve to 18 months ago we had a market standard of 250 to 300 milliseconds as latency between the client and the bank, and that was at the cutting edge. We're now seeing 10 to 30 milliseconds... we can [execute] up to 150,000 trades a day. [Banks now need] a system that can bring in 300 trades a second.

What challenges does the eFX industry face?

The dilemma going forward for a lot of eFX banks is the more products you put on your platform, the more latency you're going to have. There's only so much bandwidth between you and the client. The question is: do you want a low-latency, high-volume, high-frequency trading system to connect to your client, or do you want a single bank platform that has got all the bells and whistles and offers all products, but might be slightly latent?

What do you see as the key stumbling blocks?

Getting the infrastructure and the connectivity between the clients is the key. Everyone is moving to 'tri-location', where basically you clear three centres - Asia, London and New York - to decrease your latency and increase your ability to not only receive trades, but to risk manage the trades.

What will differentiate the winners and losers in this market?

You have to offer the holistic product, but [tailored] to your marketplace. It would be very difficult for a second- or third-tier bank to take on the power of the tier one banks.

The problem with eFX (electronic foreign exchange) is that it's a highly concentrated market. With three of the top players taking close to 45% of the eFX volume, and I think the top six taking more than 70%, you have to come up with a defined strategy that suits the bank, portfolio and client base.

Will the banks with the deepest pockets necessarily be the winners?

Clearly investment needs to be done. [One] way [to curtail] that spend is to define where you want to compete, so you may not want to take on the hedge fund community, but you might say our strength is corporate and retail.

What can banks do to better compete?

It's all about targeting and segmentation. I think with FX and especially eFX, the beauty of it is you can analyse it very well, because it's electronic, and so real-time data and real back testing can be done quite effectively.

How will eFX change in the next five years?

You're going to see the continued move towards aggregation, and these multi-bank platforms. Banks especially will have to share their client base.

Are you losing a valuable part of the one-to-one client relationship with eFX?

The relationship has strengthened. We have an eFX sales team, and a bank sales team, so one client may speak to two different people offering two different strengths. One is giving insight on our connectivity, latency issues, and how we can improve the speed and efficiency of the connection with eFX, and the other one is a more macro, traditional phone banking relationship.

Gerald Dannhaeuser, Head of FX sales

In what way have clients' priorities evolved?

If you look back five years, the main players in the market were corporates [and] maybe central banks. The market is now much deeper and more segmented. Every one of these client segments requires different answers or has different problems to deal with.

What is the challenge for banks in adapting to this environment?

The number of market participants on the bank side is shrinking. There are fewer and bigger players, and the middle tier is disappearing. You can only focus on dominating a certain market, or you become a niche player, but you cannot be a me-too player in future.

Will the middle-tier FX players disappear?

Yes, we're going to lose that middle ground, where investments are not affordable. You might still have a niche or a place in your home market, you might still add something to your core client segment, but you will not have the ability to play on a bigger scale.

How hard is it to manage on a day-to-day basis?

That's the challenge the industry is facing, and the important thing is really to know what you want to be, to each and every single client, so you can derive the consistent strategy for your client and be committed and competitive.

How has your client base evolved in the past few years?

We have added clients on a global basis [such as] central banks, banks, hedge funds, institutional asset managers and insurance companies. We have shifted from the corporate space into the institutional space.

How will rules forcing over-the-counter derivatives to trade through central exchanges affect business?

I always tend to compare it with the introduction of new accounting standards three to four years ago. That also gave a shock to the market. But we found solutions.

But what about the argument that FX should not be subject to a broad-brush regulatory approach?

The over-the-counter character of FX is still very important because every client might have different cash flows, and that's something that needs to be addressed in the discussion with the regulators.

What will the competitive landscape look like in five years' time?

The trend that we have seen in the past few years will probably continue: fewer, stronger players [with] more market share concentrated on the top end. But niche players are also doing particularly well.

How can banks retain clients but win new business?

What clients value is price and execution. But I [also] think clients value more than just always [achieving] the best price at a certain millisecond in time. The key is the advisory part. Clients have a lot of different exposures. It can be the generation of alpha, it can be dealing with uncertain exposures or [it can be] hedging cash flows. Only if you are good in many areas will you succeed.

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