FX Supplement 2014 | Overview

Will regulation repair forex’s damaged reputation—and are banks ready for the culture change?                                                                                        

Banks and other FX providers are adapting to an increasingly regulated environment: The foreign exchange landscape is indeed changing. Many big banks have shut down proprietary trading desks, and some have lost star traders to hedge funds. Regulatory changes and increased scrutiny are shifting FX trading volume away from the interbank market and toward electronic platforms. Margins have narrowed as the system becomes more commoditized. Telephone trading and chat rooms have gone quiet.

Although the FX market remained vibrant and liquid throughout the financial crisis, the recent extended period of record-low volatility is raising concern that the changing regulatory mix is depressing interbank volumes, says George Saravelos, currencies analyst at Deutsche Bank. The lower transaction costs from electronic trading may also be reducing volatility, he says.

Deutsche Bank shut down its proprietary FX trading desk in London in December 2012. Early this year, Kevin Rodgers, the bank’s London-based global head of FX, let it be known that he would retire in June to focus on academic and musical/theatrical interests. As of early October, a replacement had not yet been named.

Citi, another one of the world’s largest FX banks, lost its two top FX officials this year. London-based Anil Prasad, global head of FX and local markets, left to form his own hedge fund, to be replaced by Nadir Mahmud, who was head of global markets for Asia-Pacific. And Jeff Feig, managing director and global head of G10 FX at Citi, left the bank in June to join Fortress Investment Group, a New York–based global investment manager, where he is co-head of the liquid-markets business, which includes the firm’s macro funds.

There may well be challenges and costs in implementing
the changes, but enhancing confidence in the market is crucial, and the industry will adapt to embrace these recommendations.

~ James Kemp,
Global Foreign Exchange division of the Global Financial Markets Association

Though none of these personnel changes has been linked to the widening investigation into alleged manipulation of the FX market, more than 30 traders at leading FX banks have been fired or suspended in the past 12 months. This purge has cast a pall over the market.

The shrinking number of dedicated interbank participants and a growing herd mentality could lead to sudden, unexpected shifts in exchange rates. David Rodriguez, quantitative strategist at DailyFX, a news and analysis portal owned by FXCM, says: “The dollar tumbled and the Japanese yen surged [on August 6] as an aggressive wave of selling led the dollar to its worst single-day loss against the yen in four months. The dollar’s exchange rate fell sharply in the typically quiet period after the European market close. Traders initially suspected a ‘fat finger trade’ was to blame—someone had mistakenly placed an especially large sell order. But it turned out to be simply panic selling which forced many nervous speculators to exit their leveraged positions.” The unexpected volatility underlines the risks below the surface, as FX markets’ overall volatility falls to near-record lows, Rodriguez says. “Clearly, many traders fear the next major move is just around the corner, and any especially crowded trades seem at risk, as speculators will flee at the first sign of danger,” he says.


Rodriguez, DailyFX: Clearly, many traders fear the next major move is just around the corner, and any especially crowded trades seem at risk, as speculators will flee at the first sign of danger.

According to a recent report by Stamford, Connecticut–based Greenwich Associates, the slump in FX trading volume has all the features of a cyclical decline, as hedge funds and central banks have slowed their FX trading. But, the report continues, in reality the slump could reflect a major shift in the FX business model. “Greenwich Associates believes there are FX-specific factors at play that signal a secular shift as well,” the report says. “Regulatory concerns and tightening budgets could lead to most FX trading being done on an agency basis and executed via exchange. Dealers who invest in their electronic platforms will benefit from this potential shift to agency-style trading.”

In general, only the biggest banks can afford the cost of building these big platforms. Financial institutions as a whole increased the share of their trading volumes executed electronically by three percentage points to 77% last year, Greenwich Associates says. Nearly three-quarters of global FX trading was electronic last year, up from 71% in 2012.

“Electronic FX volumes are also getting at least a minor boost from currency options, which are often traded through single-dealer platforms that allow for a maximum level of customization,” Greenwich says. However, its Market Structure and Technology practice recently released research showing that regulatory burdens set to take effect in the coming years could severely slow the growth in FX options trading.

Until now the FX industry has been largely unregulated. In the wake of allegations that the 4 p.m. London fix for benchmarks was being rigged, however, further regulation is likely. The UK Treasury said in June that it was working with the international Financial Stability Board to clean up the market. A task force set up by the FSB recently proposed a series of 15 reforms, including extending the time for the London fix from one minute to five minutes. It also wants banks to separate their fixing orders from the rest of their FX business and to take other steps to minimize conflicts of interest. The FSB, however, did not go so far as to recommend a global utility to match fixing orders. The London fix is used to create a benchmark to value trillions of dollars in investments.

More regulation, more compliance costs and more technology replacing human traders will continue to change the market. The new way of doing business could make it harder for most banks to make a profit from FX trading.



The benchmarking scandal in the FX market has shaken faith in the system of trading currencies that enabled a dozen or so major banks to allegedly manipulate the world’s largest market. The global investigations may be settled soon, but the damage to the market’s reputation could be lasting. Recognizing the need to restore a sense of fairness, transparency and liquidity to the global currency market makes changes inevitable. Many market participants have welcomed the Financial Stability Board’s recommendations for reform, particularly those relating to the 4 p.m. London fixing. James Kemp, managing director of the Global Foreign Exchange division of the Global Financial Markets Association, which represents many of the dealers in the market, says: “As the report highlights, there may well be challenges and costs in implementing the changes, but enhancing confidence in the market is crucial, and the industry will adapt to embrace these recommendations.”

If the industry does not act quickly to ensure appropriate behavior and implement the FSB report’s recommendations, the authorities may conclude that further regulatory reforms are necessary, the FSB has warned.

The Foreign Exchange Professionals Association (FXPA), a new Washington, DC–based trade association representing a wide range of interests in the FX market, was formed in September to provide advocacy for the industry. “This is a watershed moment for FX, as we redefine who we are as an industry and where we’re going,” says Derek Sammann, global head of commodity and options products at CME Group and vice chair of the FXPA. The group includes buyside institutions, exchanges, clearing houses, trading platforms, multilateral trading facilities, technology companies, banks and nonbank market participants.

In June, Thomson Reuters revised its FX trading rules and updated is Rule Book. “We want to make sure people are using the platform for its intended purposes—genuine commercial interest in trading—and ensure that’s the kind of liquidity we’re getting,” says Phil Weisberg, global head of FX at Thomson Reuters.