Deutsche’s former FX head says the transformation is coming

By Kevin Rodgers Former global head of foreign exchange at Deutsche Bank

When I used to work in FX, I hated the Euromoney survey with all my heart. I wasn’t alone: I think that the spirits of all my colleagues and my rivals used to sink each year at the thought of having to ring up clients and pester them for votes.

That’s not to say that the survey wasn’t extraordinarily useful – it was and remains the best benchmark of market penetration and performance we have. It’s just that seeing the burning resentment in a normally placid salesman’s eyes when I reminded him – again – to call fund X or Y rather took the edge off things.

This year, though, is different. This year the staff at Euromoney did all the canvassing, making the process painless for banks and much less of a hassle for clients.

The first thing that strikes me is that, despite the changes to the survey process, the 2015 Euromoney FX survey is remarkably consistent with previous years. True, overall reported volume is lower, which is probably mainly a result of the change in methodology, but the top 10 banks in 2014 are still the top 10 banks in 2015, albeit with the cards slightly shuffled as if by a lazy croupier.

The top three of Citi, Deutsche Bank and Barclays remain unmoved, although in the places below the podium, JPMorgan and Bank of America Merrill Lynch rise while UBS and HSBC fall. RBS, once one of the mainstays of the top five, is on the verge of falling out of the top 10. And that top 10 looks an increasingly distant dream for the likes of Morgan Stanley and Credit Suisse, which would have been racing certainties for that position a few years ago.

The same observation can be applied product by product and client sector by client sector. There are some risers and there are some fallers, but the shape of the market structure has not changed. The same banks dominate electronic trading and options. Ditto the corporate sector, although HSBC knocks Citi off top spot in a very close race. In real money, Citi edges Deutsche by a margin almost as tight as you’d get on a euro/dollar trade. It is safe to say that, at least seen from the vantage of market shares, and with eyes slightly squinted, the 2015 survey shows an evolution from that of 2014 but nothing much more dramatic.

I am sure there will be the normal heated inquests in banks’ FX departments about why they fell from fifth to sixth in one category or the other, but – and I realise I say this from the lofty, academic calm of retirement – they are wasting their energy this year. My advice? Wait until 2016 to have a proper scrap.

The one bank where the market-share movements in this survey do appear to be unquestionably part of a larger, longer-term pattern is RBS. Falling two places from eighth to 10th in overall share is a continuation of its steady fall from fourth in the 2009 survey. However, its retained hold on fifth in Corporates looks to be evidence of a strategic shift to its core customer base. No doubt this is a result of obeying the wishes of its owners, the UK government.

But what clues does this survey give us about the FX market in the future? The same long-term forces are at work on the market as always have been. First, there is the continuing impact of technology. It is instructive to look at the concentration of market share in various client and product categories in this light. The top five banks in electronic markets, a sector dominated by high-frequency trading clients, take nearly 60% of volume.

In real money and corporates though, concentration is much lower – the top five banks take 44% and 39% respectively. Even more striking, the electronic market share gap between the frontrunner (Deutsche) to the number five bank (JPMorgan) is around 10%; with corporates the equivalent spread is less than 3% (HSBC first, RBS fifth); and with real money (Citi to HSBC) it is less than 2%.

Why are the corporate and real money sectors much more closely contested? In part, this can be explained by the need to share business resulting from real money panel rules, and by the spread of lending to corporates.

A big part of the difference lies in technology. What do you need to be best at as a bank to satisfy an HFT fund through an electronic platform? In a word: price. The (pretty much) one-dimensional nature of this sector lends itself to a technological arms race – speed, connectivity – with its consequent winner-takes-all structure.

But real money and corporate clients are trickier to service; their needs are much more varied. Although the leading banks have thrown a great deal of money, time and effort at serving them electronically, none of them has landed the knock-out blow with a platform that dominates.

My guess is that the search for the winning technology for these sectors will intensify dramatically, especially given the perceived attractiveness of corporate and real money flows.

The search for the winning technology will intensify dramatically, especially given the perceived attractiveness of corporate and real money flows Kevin Rodgers

One reason these clients are well-regarded is that their business is steadier and less subject to volatility than leveraged funds’ flows. Within the industry it is well known that, almost uniquely in the line-up of products in a typical bank, FX departments tend to benefit from higher volatility: more uncertainty prompts more trading at wider spreads.

Of course, the opposite is also true. In the last couple of months of my career in the summer of 2014, FX volatility descended to unprecedented, record lows (Deutsche’s CVIX index of volatility, which normally averages around 10%, fell to 5.2%). There was real concern that central banks may have succeeded in squeezing volatility out of the market permanently.

We shouldn’t have worried. Although its effects are not visible in the 2015 survey, the SNB’s shock decision to abandon the EUR/CHF floor and the chaos that ensued will be of immense importance since it signals the beginning of the end of central banks’ willingness and ability to impose calm. With continued uncertainty around Greece, the UK talking of an EU referendum, and the likely start of rate hikes in the USA and elsewhere, it looks to me as if volatility is back to stay.

The other main driver of change in the FX market is the continuing aftereffects of ‘the investigation’. I’m not going to comment on the wrongdoing it discovered and the fines that were imposed, except to say that I understand the anger and frustration of the overwhelming majority of the market who did nothing wrong but saw their work undone by a tiny minority. To paraphrase Churchill: ‘Never was so much, made by so many, blown by so few’.

It is vitally important that the industry gets to a new code of conduct quickly. It always operated by guidelines that were perfectly sensible (if a little vague), but which were geographically fragmented and had gradually become out-dated. Given the enormous scale of FX, its global reach and its importance, that was simply not good enough, especially when it came to the clouded issue of the sharing of information with clients.

I was heartened to read that the Bank for International Settlements is optimistic that there will be an agreement on a global code of conduct after the efforts of Reserve Bank of Australia assistant governor Guy Debelle. The market needs it.

On the subject of regulation, at first sight it does not appear to me that the changes brought in over the course of 2013 and 2014 (I am referring to rules around swaps reporting, swap execution facilities, etc.) have had a huge impact on the survey results. Whether they will make the market any safer is also debateable.

In a wider sense of regulation though, it is likely that more pressure on balance sheets may change things. Banks are increasingly trimming their operations. The concept of the universal bank – offering every product to every client type everywhere – is gradually being abandoned by one bank after another.

Could this be mirrored in FX? It is interesting that, leaving the powerhouses of Citi and Deutsche aside, the next biggest providers in the options market (Bank of America Merrill Lynch, HSBC and BNP Paribas) are not the biggest in the market as whole. This may be evidence of greater specialism and focus.

It is also the case that we should expect non-bank liquidity providers to become more important in spot. There is nothing really to stop them. Electronic provision has become an almost purely technological battleground (as we can see in the market concentration numbers) and non-bank outfits have the strong advantage of specialism.

In this survey we see investment manager GSA Capital enter at number 34 and, although no non-bank provider made it into the top 15 in this survey, I would put money on them doing so in the future. Will Tower and Citadel (to name but two) be that far behind GSA?

Having said this, I do not expect a similar push by non-banks in the options market. It’s more difficult to clear risk in options than in spot (which is why big options houses have books with thousands, or tens of thousands of strikes) and the necessary commitment to building risk and pricing systems sophisticated enough for the over-the-counter market is probably lacking at the moment, even in the biggest funds.

The numbers to watch Next year’s survey and the one after it will have as the forces of technological change and specialisation do their work inexorably, probably in an increasingly volatile market.

'May you live in interesting times' – as I can now say from the safety of retirement.

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Kevin Rodgers was global head of foreign exchange at Deutsche Bank until June 2014. His book on the computerization of banking will be published by Penguin Random House in 2016.