Although the volume of trading in foreign-exchange markets rose by 32.5% in the Bank for International Settlements’ (BIS) 2013 triennial survey from three years earlier – to an average of $5.3 trillion per day, up from $4.0 trillion in 2010 and $3.3 trillion in 2007 – there appears to have been little if any concomitant follow-through in banks’ revenues from the sector, judging from recent results.
Although banks generally do not break out their specific FX figures from those of their broader fixed-income divisions, looking at the latter provides little reason for optimism on the former.
Most recent and spectacular was Deutsche Bank’s announcement of a €1 billion overall loss in Q413, with fixed-income trading revenues declining by 31% over the period, although the sector’s revenues at the big Wall Street banks fell by 8% on average over the fourth quarter as well.
Moreover, according to an accompanying statement by Anshu Jain, co-chief executive of Deutsche Bank: “2014 will be a continuation of some of the trends we have seen. Items like litigation, impairments, the operating environment – all of those will remain challenging.”
More specifically, in the case of the top-10 global investment banks (see chart below), judging from figures worked through by financial services analytics company Coalition, revenues from G10 FX were down by around 6% in the last period surveyed (3Q13 compared with 3Q12) and are forecast to have dropped by 7% for 2013 as a whole, compared with the previous year.
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As alluded to by Deutsche’s co-CEO, a key part of the reason for this decline was that FX volatilities fell substantially last year, to around pre-financial crisis levels, says Jane Foley, senior FX strategist for Rabobank, in London.
“Across the G10 currencies as a whole, the past year has seen volatilities drop markedly, with one or two exceptions, so the opportunity to generate revenues dropped significantly as a result,” she adds.
Looking ahead, even though the global Volatility Index (VIX) jumped by 7.2% on Thursday, and by 14% on Friday, it still only stood at around the 16 level, relative to its 20-year average of about 20.50, and indeed has spent most of this year so far trading below 13.
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According to Coalition’s head of research and analytics George Kuznetsov, in London, the latter part of 2013 was characterized by substantially lower volumes and weakness in forward FX in particular, as the generally low interest-rate environment across the sector made forward deals less appealing.
Additionally, low volatility and low rates meant that several of the main global investment banks were negatively affected by a poor performance in FX options.
Before the notion that economic activity in the developed economies, and the US in particular, gradually began to gain traction in the second half of last year, the top banks’ FX revenues from emerging markets (EM) were exhibiting a positive trend, says Kuznetsov, especially in the Asia-Pacific region, before slowing down in the second half as global investment monies flowed back from emerging to developed markets.
The drop in the EM sector’s FX revenues as a whole, he adds, was not just a function of lower volatility in key currencies but also, and especially in Asia, a result of uncertainty over the region’s economic outlook, fuelled by doubts about the future growth rate in China.
Kuznetsov adds: “Asia’s FX revenues for the big banks over the past year have generally been tied to expectations of economic growth in the region, notably that of China, of course, both of which broadly worsened as the year progressed, whilst in Latin America the key driver was the likely direction of interest rates and, as these increased for the US, so the region did better.”
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Indeed, the key drivers for the recent outflows from the EM sector are likely to remain the continued rise in US yields, the tapering of the US Federal Reserve’s bond-buying programme and increased political risk in a number of countries, with important elections due in Brazil, India and Turkey, says Dominic Wilson, chief global investment markets economist for Goldman Sachs, in New York.
One factor, though, that is likely to continue to eat away at banks’ FX revenues is the migration of this business to non-bank trading platforms, from what had been up until say 10 years ago one dominated by interbank dealing.
“In the past five years in particular, this industry has seen a major move in trading over non-bank platforms for all types of FX clients, as various FX ECNs [electronic communications networks] have begun to offer bigger tradable lots, much tighter spreads and more currency pairs, and this will not be a transitory trend,” says Howard Tai, senior analyst, institutional securities and investments for financial consultancy Aite Group, in Boston.
Indeed, in absolute terms, the share of inter-dealer trading in global FX transactions stood at 39% in 2013, unchanged from 2010, but down from 53% in 2004 and 63% in 1998, according to the BIS’s latest triennial FX survey. The counterparty segment that contributed the most to growth in global FX turnover between 2010 and 2013 was ‘other financial institutions’, which includes smaller banks that do not act as dealers in the FX market, institutional investors, hedge funds and proprietary trading firms.
Even with the banks offering such platforms, and the corollary revenue-busting decimal point quotes that go with them, there is no guarantee that clients will favour dealing with a bank name over that of, say, a white-label firm instead.
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In this respect, says Panagiotis Spiliopoulos, head of investment banking research for Bank Vontobel, in Zurich, the past few months have done little to boost confidence in banks in general around the globe, with the latest dent in their reputation being regulators’ accusations of widespread manipulation of the 4pm London FX price fix.
With the US Justice Department, the UK’s Financial Conduct Authority, Switzerland's Financial Market Supervisory Authority, the Monetary Authority of Singapore and the Hong Kong Monetary Authority having confirmed their involvement in the probe into this latest scandal, Spiliopoulos concludes there might be a lot more to come in this regard – a situation which will further undermine confidence in mainstream banks.