Tier 1 FX dealers whitewash new strategies as market makers go for gold

It is now time for us, the electronic trading industry, to show the banks a clean set of heels and take the Tier 1 FX dealing side of our business to the next level

As was only to be expected, fear has set in among the traditional banking sector globally, as their retail and commercial divisions have become inundated with customers who are effectively giving them a “Dear John” message, unable to meet repayments, bills or business commitments.

The telephone lines of banks across the world are now jammed solid with customers, whether heads of large companies or private individuals on a modest income, call to advise that they will not be paying their loans, mortgages, commercial rents, bills or monthly direct debits for the foreseeable future due to the forced inability to work or operate businesses, which could well lead to a situation in which many banks could collapse.

Considering that the electronic brokerage sector had been reliant on Tier 1 banks for their prime brokerage facilities since the dawn of electronic trading, the banks are at a crossroads now, as they are jeopardized by their own failing retail and commercial sectors, yet have been losing market share to the market makers even before this dictatorial shutdown of businesses began.

With an aversion to certain Tier 1 FX dealing practices over the last few years by liquidity takers such as prime of prime brokerages, those being traditional single dealer bank platform stipulations such as tolerating last look execution, and the requirement of a vast balance sheet running into the tens of millions in order to maintain a prime brokerage agreement, there has been a definitive shift toward the use of non-bank market makers such as XTX Markets, Jump, and Citadel Securities, with XTX Markets for quite some time now holding the top slot in terms of global Tier 1 FX dealing market share, ahead of the banks for the first time in history.

Today, banks are starting to emit soundbytes which appear to be attempts to deflect negative market sentiment from them.

Largely, it is a difficult scenario for the Tier 1 dealers. They are engaged in high street banking, which has not been a profitable endeavor for many years now, and with the current crisis hitting them hard, is almost non-viable considering the amount of real estate, staff, regulation, underwriting criteria and operational cost required only to lend very small loans and then find that they will not be repaid.

They are also engaged in Tier 1 FX dealing, which is by far the core business of most of these banks, and understandably so. It requires just one office – usually in Canary Wharf, London – a team of astute dealers numbering just a few hundred, in one place, with no logistical, real estate or huge HR costs or traditional business overheads, no underwriting and no small individual time-consuming deals with narrow margin and high risk.

The FX market is a huge one for most of the Tier 1 banks in Canary Wharf, however they have put up their own objectionable methods over the years, including the aforementioned requirement of a $50 million minimum balance sheet by a prime of prime in order to maintain a counterparty credit agreement for OTC trading, and the odious practice of last look execution. 

This month, Deutsche Bank, whose Canary Wharf-based operation was once number two in the world for FX market share on its single dealer platform but now languishes in seventh place, has issued a fear-filled message.

The bank has stated publicly that it is confident that its new strategy and restructure has made its business more resilient in light of disruption from the potential spread of coronavirus across Europe.

Deutsche Bank chief executive, Christian Sewing, outlined the risks the coronavirus imposes on its business in a message to staff, but gave assurance that it has strong capital and liquidity base to manage further disruption.

“We are far better equipped for a difficult phase in the financial markets now than we were just a year ago,” Mr Sewing said. “Watching our performance in the quarter to date, it is clear to me that our new strategy is not only an important prerequisite for growth and sustainable profitability, but that it has enhanced our flexibility and resilience – especially in an unfavourable environment.”

Deutsche Bank confirmed in July that it would implement the biggest business overhaul the bank has seen in a decade, with plans including a targeted reduction in adjusted costs of around €6 billion by 2022 and the loss of approximately 18,000 full-time positions. The institution also agreed to transition its prime brokerage and electronic equities franchises to BNP Paribas following years of doubt on sustainability of the businesses.

“We have implemented appropriate measures in line with the situation on the ground or in the respective area of the bank. Many teams have switched to split mode, while others are partially relying on staff working from home. We have reduced business travel to a minimum and have cancelled large-scale events,” Mr Sewing said.

JP Morgan, Goldman Sachs and other major banks have also reportedly taken similar precautions by splitting some of their teams and warned staff to be prepared to work from home.

As inefficiency sets in, and the trading desks are affected, this type of message is really a placebo, attempting to calm the worries of liquidity takers as well as staff.

How can OTC derivatives firms with prime brokerage agreements be sure that the market execution will be done in a timely manner in this volatile time, when a lot is at stake and huge requirements are insisted upon by the banks?

Meanwhile, the market makers are flawlessly going strong. XTX Markets leads the pack, with HC Tech and Jump Trading just behind them, ahead of the single dealer platforms of UBS, Goldman Sachs, Bank of America Merrill Lynch and BNP Paribas, all once invincible FX dealers which every liquidity taker had to bow down to in order to maintain their OTC counterparty agreement.

The pattern among market makers has been repeated in the retail FX sector this month. The b-book firms which take risk onto their own dealing desks (NOT bucket shops, proper companies that abide by correct pricing, yet execute on their own dealing desk instead of sending the orders to a bank) have been making an absolute fortune.

The markets are volatile and trading activity is running at a very high level during the global lock down period, which means many retail traders are taking high risks and making trading losses, thus the market maker wins. Brokers which conduct their own risk management and which operate a b-book model according to proper pricing are currently making a fortune. The only thing they should bear in mind is that if current trading activity is very high, yet clients are losing, innovative methods of gaining new clients and encouraging them not to make rash decisions will become part of the customer care mantra.

As I look out over the tumbleweed blowing across Canada Square, we are definitely witnessing a time at which good quality market makers can take the lead and give traders what they want: Good quality, fast execution with no last look practices, with low costs due to not needing to lodge $50 million in an escrow account only to find that the bank that requested it is struggling and will reject trades.

We are at a time in the world markets where the electronic trading sector can move things forward. The prime of prime brokerages with their extremely comprehensive and highly sophsiticated systems to connect to live markets across the world, the retail brokers with their own quality infrastructure and risk management systems, and the market integration specialists that offer high-tech risk and analytics systems.

It is our time now to make the mark as the leaders of the industry and take the place of the flagging banks for Tier 1 FX dealing, in a credible, equitable, cost effective and efficient manner – which is, after all, what today’s traders want.


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