New Change FX, a provider of independent mid-rate prices, is developing a peer-to-peer matching platform it says will enable corporates to net down their portfolios before going to the FX market, reducing both their costs and market footprints.
The platform, which does not yet have a name, will have tightly controlled membership, although which institutions would be eligible and which not is yet to be decided, says Andy Woolmer, CEO at New Change FX.
It could operate as a dark liquidity pool, or be fully lit, depending on what its members wanted. But it would complement, rather than replace, corporate trading activity in FX, and could be ready for launch within months.
Woolmer says he has had positive feedback in his conversations with institutions about his proposed offering. “Asset managers often ask how they can reduce their market impact,” he says. “In our view the best answer is by putting on smaller trades. They can achieve this by netting down their positions, meaning a smaller transaction. If they can reduce their transaction size by even 5%, that can mean a significant impact on cost.”
Woolmer believes this P2P matching solution will be of considerable interest to institutional traders, and has a better chance of gaining traction than a large P2P liquidity pool such as CurrencyFair, or one that incorporates crypto-currencies, such as Ripple. “The industry has been trying to build liquidity into a P2P solution but that is possibly the wrong approach, as the biggest impact on cost comes from netting down positions,” he says.
“This needs to be done internally and then externally among peers. This process means that the position sizes are reduced, there is no information leakage to the FX markets and the client can go to market with whatever is left over. Netted trades might cost as little as $10 per million to complete, whereas trades done in the open market often cost more than $100 per million to execute. The benefits are clear if netting can be achieved.”
If successful, the development will amount to another challenge to banks' FX trading businesses, potentially meaning clients have declining volumes to be traded on their behalf in the market.
While the world's biggest banks have been tightening their grip on the currency markets in recent months, the emergence of P2P platforms could pose a risk to their dominance, and has already started to eat into banks' FX trading profits.
Adam Myers, a currency specialist and former head of European FX strategy at Crédit Agricole, says: “P2P FX is the next real threat to banks' profit margins.”
He estimates that around 95% of the high-volume but low-profit FX business is done with large institutions and corporates and is concentrated in the hands of a small number of top-tier banks – with the remaining 5% satisfied by boutique liquidity providers offering their local currencies.
But although retail FX trading constitutes a relatively small segment of the market, it is highly lucrative, he notes, and the inroads P2P exchanges have made here are hurting banks.
“Although current P2P volumes are likely a relatively small proportion of FX trading overall, their rapid increase in coming years should see banks eventually squeezed out of the market,” adds Myers.
The nightmare outcome is the emergence of a P2P exchange with sufficient liquidity and trust for it to be attractive to corporates, giving P2P providers a foothold in the higher-volumes business that has so far eluded them. But this seems some way off: providers would need to overcome the trust issue: there might be a reluctance among the institutions with large FX trading requirements there to consider changing their trading behaviour unless the alternative on offer is proven.
There is no solution that right now offers the kind of liquidity and range of currency pairs that would make it a viable alternative to the banks for an institution. It is possible to envisage P2P platforms emerging that offer sufficient depth for highly liquid pairs such as euro/US dollar or US dollar/yen, but banks offer a much broader service than that. A P2P platform offering less-liquid currency pairs, non-deliverables and options is clearly some way off.
This is one place banks see their advantage, and whether or not P2P systems will be able to meet corporate needs in these kinds of products remains to be seen.
Claude Piana, head of global market sales for Société Générale Network, says: “Institutions and corporates need a quick and efficient access to the FX market in order to either take a position or hedge an FX risk. They want to hit the market whenever it suits them. They are not prepared to wait for the exact opposite order, in terms of currency, price or amount. P2P as a marketplace is not as efficient, and is used mainly as a marketing tool.”
There is also the question of whether the need is really there for such an offering. One FX trader at a large European bank says: “The bid-offer spreads in FX are so tight and the liquidity premium so small, it is not a big cost saving disintermediating the bank. I don't think it is worth the client taking the risk of doing it on their own.”
Piana agrees: “The bid-offer spreads are amazingly tight in the FX market. Price is what matters for final clients, and the bid-offer margin."