With lackluster volatility putting foreign exchange trading desks to sleep in 2017, it was a challenge for FX dealers to make money, according to a Greenwich Associates study. With MiFID II changing the sales calculus and technology dominating brokerage decisions alongside sales coverage, major banks invested heavily in 2017 without much return. That was until the volatility of February 2018 struck.
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Banks around the world invested heavily in their FX businesses over the past year. While the slow 2017 market activity dulled dealer profit margins, it might have been a pause that refreshes.
“Banks needed to get their FX desks prepped and ready for the sudden reappearance of volatility in February 2018,” said the annual Greenwich study titled “Recipe for FX Success: Right People + Right Technology.”
The bulk of investments made were in technology, which is increasingly important but also the source of continual spending need. What was yesterday’s must-have feature is today not as unique. “Building a global FX platform is expensive—and maintaining these platforms is becoming more costly due to the need to roll out new technologies continually.”
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But it is not just technology that matters. Quality sales coverage is also essential to institutional FX coverage, which makes the challenge one of finding balance.
“Some banks have the right people, but not the right technology,” Greenwich Associates consultant Satnam Sohal said. “A strong technology platform helps free up sales traders, who can then spend less time on operational issues and more time with clients.”
In speaking with 1,455 top-tier global accounts – central banks, large corporations, hedge funds and other financial institutions – Greenwich noted that execution algorithms are the latest must-have feature. Even though the use of FX execution algorithms is currently low, “it will grow in importance over the next three years—forcing dealers to deliver.”
Greenwich’s 2017 Future of FX Algos Study predicted that 31% of contingent orders are expected to be executed through algorithms in two to three years, followed by 27% of fee-based and 16% of benchmark trades.
“While algo adoption has so far been higher among the largest institutional users of FX, a steady rise in the use of TCA should aid further growth,” Greenwich Associates consultant Tom Jacques observed.
The technology spending has been done so as “to keep up with Citi and J.P. Morgan, which tied for first place in the Global FX Market Share study. “These two banks have leveraged extensive global networks and best-in-class technology platforms to build a lead over the rest of the market that is wide and still growing.”
UBS and Deutsche Bank tied for third place as Goldman Sachs, HSBC and Bank of America Merrill Lynch tied for fifth in global FX market share.
“While individual banks might have strengths in either high-touch sales or e-trading, the two channels are becoming increasingly interconnected,” the report noted. “It’s getting harder to be especially good in one area without the other, so dealers have had to invest in both.” One such example is J.P. Morgan, a firm that traditionally excelled in electronic trading but now also ranks near the top of the industry in sales coverage quality.
Clouding the sales picture is MiFID II. The European regulations require “best execution” to drive brokerage decisions, forcing the buy-side to value execution quality, according to the Greenwich study. This comes as FX clients continue to place a significant value on the ideas and market color provided by their sell-side coverage. “However, as clients move to comply with new MiFID II rules on research, some market participants—primarily in Europe—are imposing strict restrictions on sell-side firms and their traders,” the report said. “If you don’t have a research contract in place with these firms, you are prohibited from even speaking with them. No calls, no unsolicited emails—nothing.”
