Currency trading is taking over from equities as the challenged business in investment banking. Resurgent volatility in foreign exchange markets during September and October is unlikely to offer more than a temporary respite for the business.
Margins in FX have been declining steadily this decade amid the rise of electronic trading. At the same time, a regulatory clampdown has forced banks to switch away from a so-called principal model, acting as a currency wholesaler, to a less lucrative agency model, matching buyers and sellers. An agency-brokered $1 million spot euro/dollar trade generates just $2 in commissions, 90 percent lower than a principal-dealing approach, according to capital markets consultancy GreySpark Partners.
FX trading platforms are expensive to maintain. To cover the cost of equity in the business a bank might need to make $1.3 billion in revenue, according to Greenwich Associates. Only a few will have achieved that last year.
These economics are forcing change. Headcount in the business fell 25 percent in the five years to 2013 at the 10 largest investment banks, as revenue plunged 60 percent, according to Deutsche Bank. The leading firms now employ only about 4,500 staff in total, including those covering emerging-market currencies.
Meanwhile, some institutional investors are looking to get direct access to banks’ trading platforms. If this trend continues, banks’ FX businesses may end up being only infrastructure providers, competing with the likes of interdealer broker ICAP and Thomson Reuters, the parent company of Breakingviews.
And in the background, there’s the fallout from an alleged market-rigging scandal. JPMorgan said a new $1 billion legal expense in the third quarter included its best estimate for FX fines.
There is some hope for dealers. They could charge other areas of their firms for using FX services, as internal clients. European regulators are struggling to standardise definitions for even relatively simple instruments, such as bespoke futures contracts known as “forwards,” which account for 13 percent of the overall $5.3 trillion daily market. Commissions here should stay higher.
Recent choppy markets could be good for FX. But the relief from any rebound in revenue is likely to be a brief respite from secular shrinkage.