The removal of the 1.20 peg on the EURCHF pair by the Swiss National Bank was an unprecedented move by a central bank which created tremendous volatility without warning, sending both the markets and the companies which handle FX order flow into the most frantic period ever experienced, resulting in many changes to the industry’s risk management model.
Just a few months have passed since January 15, the day on which this took place, and Wayne Roworth, Co-Head of e-FX at Sucden Financial has shared his opinions with LeapRate on the areas that are critical with regard to what has become regarded as ‘Black Thursday’.
The Prime-of-Prime world has changed dramatically since the events of January 15th; some names have disappeared from the landscape, while for many of those who remain in the FX prime brokerage space, conditions have become more challenging. This has created further opportunities for some, namely the largest Prime-of-Prime (PoP) providers.
In the two weeks following the SNB event Sucden Financial felt it was critical to meet with all of our prime broker and liquidity providers, to get a feel for what was happening and how the world of FX world may change.
Our conversations focused on a number of areas:
Collateral / Balance sheet
It was clear from these conversations that there was a fundamental change happening and the result would be an increase in the minimum balance sheet requirement, coupled with higher collateral obligations. In the past month we have read in the press that a number of these changes are now in effect and many PB clients are looking for new homes. Sucden Financial is fortunate to be in a strong financial position that comfortably exceeds these new requirements.
Counterparty profile
At the same time it seems that collateral and counterparty size is not the only determining factor. We understand that some tier one prime brokers are reviewing their exposure to the entire retail FX market. Sucden Financial is a highly diversified company, meaning the banks do not generally categorise us as an FX broker. We are a multi-asset brokerage with a significant presence in futures, particularly metals and soft commodities.
We believe there is still significant risk for those firms solely focused on FX, many of which could lose their PB relationship, so it is important to have a backup in place. At Sucden Financial we have two PBs, but uniquely we also have direct relationships with nine banks, further reducing our dependency on any one provider.
Spreads
Most bank liquidity providers are talking about a move away from market share and towards profitability; this is a real trend reversal. First and foremost many banks looked to widen spreads and discourage less profitable flow. Furthermore, they are carefully considering who they stream liquidity to and how it is consumed.
Sucden Financial understand that a good proportion of volume has been unprofitable for a long time and they are no longer willing to offer tight pricing in order to drive higher volumes. Since Sucden Financial operate in a clean and transparent way, our liquidity providers are happy to compete for our business, enabling us to offer our clients some of the tightest pricing available in the market. Combined with a dedicated liquidity management focus, the outcome is significantly improved spreads, which equate back to early 2014 levels when volatility was lower.
Prime brokerage costs
PBs intend to raise their fees; we have already started to see this materialise and believe it will inevitably filter down to the clients of Prime-of-Prime brokers. Fortunately Sucden Financial is in a fairly unique position as a PoP with so many direct relationships. This is not only exceptional by nature but it also enables us to keep our cost base low, as we do not need to give up every trade to our PB.
Margins
Sucden Financial understand that many of the banks have started to raise margins for their clients, particularly those they view as higher risk. The higher requirement has already been passed on by largely all PoP firms who have increased the margins they require from their clients.
Prime of prime brokerages asking for 2% on FX majors seems to be the norm now and we see this change as permanent or at least for the medium term, if you’re an optimist. We had wondered whether this might trigger a significant decrease in volumes, but so far clients have accepted the increase in margin and volumes are higher year-on-year. Sucden Financial believe that the increase in market volatility since September 2014 will likely remain throughout 2015 and the outlook is positive.
Risk
In the aftermath of the SNB move almost all FX market participants are asking the same question, “What could we have done differently?” There’s a renewed focus on risk management systems that reside on the trading infrastructure. Low latency pre-trade checks, combined with intelligent instrument concentration rules are the main subject of conversation. As you would imagine there is a special focus on currency pairs that are not free floating.
Future
We are still in the eye of the storm as far as the post SNB changes are concerned and although we have seen some unfortunate casualties and urgent course corrections it is highly unlikely to conclude here. The recent adjustments make the next six months very difficult to predict let alone the landscape beyond.
However, we would expect there to be a significant rebalancing of market share in favour of larger, better capitalised and diversified Prime-of-Prime brokers who can maintain access to tier one bank prime brokers and/or direct credit relationships.
One thing already cited is the effect on retail aggregators; this sector will in all probability see the greatest long term change and consolidation is inevitable. Whether through cost increases or regulatory shift, there will likely be a leverage constraint but I view this as a positive for the long-term and part of a natural cycle and maturity. The underlying demand remains healthy and Sucden Financial very much remains a key partner for medium and large brokers in this space.
This article represents the views of, and was compiled by Wayne Roworth, Co-Head of e-FX at Sucden Financial