A widening probe of the foreign-exchange market is roiling an industry already under pressure to reduce costs as computer platforms displace human traders.
Electronic dealing, which accounted for 66 percent of all currency transactions in 2013 and 20 percent in 2001, will increase to 76 percent within five years, according to Aite Group LLC, a Boston-based consulting firm that reviewed Bank for International Settlements data. About 81 percent of spot trading—the buying and selling of currency for immediate delivery—will be electronic by 2018, Aite said.
“Foreign-exchange traders are much like stock floor traders: a rapidly dying breed,” said Charles Geisst, author of “Wall Street: A History” and a finance professor at Manhattan College in Riverdale, New York. “Once the banks realize they are costing them money, the positions will dwindle quickly.”
At least a dozen regulators are investigating allegations first reported by Bloomberg News in June that traders colluded to rig benchmarks in the $5.3 trillion-a-day currency market. That scrutiny may give banks an opportunity to cull more staff, say analysts including Christopher Wheeler of Mediobanca SpA in London. It's also boosting demand from clients for greater transparency in pricing and transaction charges, accelerating a longer-term shift in trading onto electronic platforms.
“The margins are very, very skinny in foreign exchange because it's easy to move onto a trading platform,” said Wheeler, who tracks European lenders. “The move by banks into electronic trading in other areas has cost a large number of jobs, and we've seen revenue come off sharply. The foreign-exchange probe won't help this.”
The push toward electronic trading probably will lower costs for customers and boost transparency of pricing, according to Cormac Leech, an analyst at Liberum Capital Ltd. in London. It may also squeeze margins for banks, he said.
Information Advantage
Human traders have maintained their role in the foreign-exchange market while disappearing in areas such as equities because most trading takes place away from exchanges. That means clients don't have a central repository showing the flow of completed orders, forcing them to piece together information about the direction of rates from traders and salesmen with knowledge of other clients' orders. People were also needed because early computerized trading systems weren't reliable and couldn't handle larger transactions, according to dealers.
“Many algorithms in previous foreign-exchange platforms were very, very basic—not a lot more than egg timers,” Chris Purves, London-based global head of foreign-exchange, rates, and credit electronic trading at UBS AG, said in an interview. “The equities world, on the other hand, had advanced algorithms with gaming technology inside of them; they would randomly split up clip sizes to provide best execution. A lot of that technology has now been brought into the foreign-exchange world.”
Deutsche Bank AG, Citigroup Inc., Barclays Plc, and UBS AG are the four biggest currency-trading banks, according to a May survey by Euromoney. The investigation of alleged manipulation already is reducing the number of spot traders at these and other firms. At least 21 traders have been fired or suspended as a result of the probe. Some are leaving of their own volition. Banks including UBS, Goldman Sachs Group Inc., and Citigroup have banned dealers from using multiparty chat rooms.
Firms such as London-based Barclays have started to cut employees amid a wider squeeze in revenue from fixed income, currencies, and commodities, according to people with knowledge of the matter who asked not to be identified because they weren't authorized to speak publicly.
“A handful of traders in a few banks have a huge information advantage they can transform into profits,” said Andre Spicer, a professor at Cass Business School in London. “They know what order flows are, and research shows order flow is one of the few decent predictors of price in this market. Ongoing inquiries may erode this information advantage by restructuring the market. This will kill off opportunities for relatively easy profit.”
Banks' income from foreign exchange already has been squeezed. Volatility, a key driver of revenue, is declining as concern that Europe's sovereign-debt crisis would trigger the breakup of the euro eased and central banks provided unprecedented liquidity to stabilize markets.
Deutsche Bank's Currency Volatility Index, which measures the market's expectation of future price swings for nine currency pairs, slumped to 7.53 percent on Feb. 17. The index was as high as 15.8 percent in September 2011.
Crimping Revenue
That decline is crimping revenue at firms including Citigroup and UBS. New York-based Citigroup said last month that revenue in its rates and foreign-exchange business was down slightly in the fourth quarter from the previous period. UBS said this month that foreign-exchange revenue declined in the fourth quarter because of “lower liquidity and reduced client risk appetite.”
Regulators are helping push more trading away from humans to electronic platforms by making some transactions more expensive for banks. The latest rules from the Basel Committee on Banking Supervision will make foreign-exchange derivatives—contracts with values derived from changes in currency rates—less attractive for banks by imposing charges for holding positions and products that aren't cleared through exchanges.
“No matter how you slice it, foreign-exchange options will be more expensive for clients to trade and for banks to take on,” said Kevin McPartland, head of market-structure research at consulting firm Greenwich Associates. “Shrinking profits from higher operational costs and the increased cost of capital may cause banks to focus on generating revenue from their traditional cash business and redirect money into technology that facilitates trading through an agency model.”
European regulators are also pushing firms to move more currency trading onto regulated exchanges to boost transparency. German Deputy Finance Minister Michael Meister this month gave his backing to such an overhaul after it was suggested in January by Bafin, the country's financial regulator.
The Basel rules are spurring the development of a currency futures market, based on exchanges. In 2005, the volume of such futures traded on the Chicago Mercantile Exchange was less than one-third of daily spot trading on EBS, an electronic trading platform owned by ICAP Plc. In 2013, CME surpassed EBS for the first time, and by December, the volume of futures traded on the CME was almost 30 percent greater than that logged through EBS.
'Clear Shift'
“The aggressive growth of the futures model demonstrates a clear shift in the landscape, with market participants looking at alternative sources of liquidity and hedging tools alongside the over-the-counter market,” said Derek Sammann, a managing director at the CME.
Two of the biggest currency-trading banks are taking different approaches to defend their share of the market. Barclays has developed an addition to its electronic platform that gives clients foreign-exchange rates aggregated from external sources. Zurich-based UBS is trying to retain the human element in its platform, allowing clients to connect directly with its sales and trading desks, in addition to accessing research covering fixed income, credit, equities products and foreign exchange.
Barclays, the U.K.'s second-largest bank by assets, last year started Gator, which allows clients to trade foreign exchange with the same technology its traders already used internally to quote prices. Gator, an extension of Barclays's earlier BARX platform, is the first offering from an investment bank to aggregate currency prices from external sources such as EBS, Currenex, and FXall, which is owned by Thomson Reuters. EBS was started by a group of banks in 1990 before being acquired by ICAP, the world's largest interdealer broker, in 2006.
Officials at Barclays, Deutsche Bank, and Citigroup declined to comment on their trading operations. Bloomberg LP, the parent company of Bloomberg News, competes with Thomson Reuters and EBS in providing news, information and currency-trading systems.
In October, Switzerland's largest bank started UBS Neo, a platform that replaced almost 100 internal systems with one that allows institutional clients to trade a range of asset classes. The system, which enables clients to connect with traders and salespeople, mimics the way Twitter lets users to follow one another.
While the system uses computer algorithms to complete client orders, a service for which clients once relied on dealers' judgment, some trades are still passed on to the dealing desk in Zurich. The firm still has about 25 spot currency traders, said a person with knowledge of the matter.
Electronification Risk
About 70 percent of Barclays's trading is electronic today, compared with less than half when it opened its first currency platform in 2005, according to a person with knowledge of the matter who asked not to be identified because he wasn't authorized to speak publicly.
“A good chunk of spot traders, maybe 30 percent to 40 percent of them, are at high risk of electronification eating their lunch,” said Javier Paz, senior analyst at Aite.
A decade ago, France's BNP Paribas SA employed about 15 spot traders and one electronic foreign-exchange team member in Paris. Today, the team has moved to London and includes six spot traders and eight people dealing with electronic trading, according a person with knowledge of the matter.
The shift to electronic trading may concentrate trading at an even smaller number of banks, forcing out competitors with a lower market share, according to Chirantan Barua, an analyst at Sanford C. Bernstein Ltd. in London. Some firms also may move toward the equities sales-trader model, where salesmen handle orders as well as provide market information.
“The old model is going away,” said John Taylor, founder of New York-based FX Concepts LLC, once the world's biggest currency hedge fund before it went bankrupt last year. “But it's better to say the old model has gone away several times. This is just the latest of those times.”
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