The largest global FX dealers are slowly gobbling up market share, according to a report from Greenwich Associates. The reason is that it is getting more and more expensive to stay in the market, as dealers find themselves an escalating environment when it comes to technology. So, in the immortal words of Grand Master Flash, “It’s called survival, and only the strong can survive.” Ultimately this could make the cost of hedging more expensive for corporate end-users as banks pass along any added costs.
“Profits and resources are getting squeezed,” says Kevin McPartland is the Head of Research for Market Structure and Technology at Greenwich Associates. That’s mainly because “regulatory pressures continue to increase, making it harder to be a profitable business.”
One of the reasons is technology, which in order to keep up companies must spend millions a year. According to the Greenwich report, the five largest FX dealers by market share globally are Deutsche Bank, UBS, Citi, Barclays, and J.P. Morgan, which together netted about 53 percent of global trading volume in 2013. That’s up from 48 percent in 2012 and 45 percent in 2011. In pre-crisis days, the top five dealers controlled as little as 39 percent of global volume, Greenwich says. Meanwhile, the closest competitors’ combined market share dropped to 22 percent in 2013.
That technology is becoming such a factor is due to regulation. Pre-crisis, clients would call dealers looking for market color, Mr. McPartland says. But now fear of saying the wrong thing has damped the enthusiasm for that personal touch. “If you have a sell-side that’s worried about what they say … they’re going to be less likely to pass on the color like they used to,” Mr. McPartland says. “Then they’re going to head to electronic platforms and trade that way because they can do it more cheaply than they could by picking up the phone.”
But while it could be cheaper for the buy-side, it’s getting increasingly expensive for the sell-side, according to Greenwich. It reports that one top-ten FX dealer estimates that it costs $600 million per year to maintain its FX platform. That means maintaining an ROE of 10 percent on the business would require an annual revenue base of $1.3 billion, according to the dealer. Revenues in 2013 were $1 billion, Greenwich notes.
Still despite the increases, the market could be disrupted in the future by the smaller players re-entering. “Electronic markets can lead to a situation where smaller firms that are tech savvy and provide competitive pricing can come in and pick up a good amount of share and change the landscape a bit,” Mr. McPartland says.
For corporate hedgers it remains to be seen how their costs will be impacted, but it’s a good bet banks won’t keep cost increases to themselves. “The cost of doing those bilateral trades will increase for banks so the question is how much will they pass on [to corporates] and the other piece is the requirement to post initial margin on those trades where they wouldn’t have before,” Mr. McPartland says. But he says that for those companies that are cash rich, “the cost of posting margin can be relatively limited if you have that cash on hand anyway.”
Mr. McPartland says it could still be a little while before all this takes place. “Derivative reform has so far had a limited impact on the FX markets,” he says. “But that will slowly start to change over time as you will start to see some FX derivatives mandated for central clearing.” They are starting to happen and will have a bigger impact “over the next couple years.”
“The world and the regulators have been focused on fixed income since the financial crisis,” Mr. McPartland says. “But now with some of that dealt with to a larger extent, FX is going to come more of a focus.”