FX Supplement 2014 | Overview

Author: Gordon Platt

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.