Spot FX Gets Walloped!

The BIS triennial survey, the most comprehensive data point, indicated that overall FX volume shrunk 5% from $5.36 Trln in 2013 to $5.09 in 2016. However, FX spot fell by a whopping 23.7%. London maintained overall geographic leadership but saw its share move down to 37% from 41% in 2013. APAC trading centers saw growth from 15% to 21% market share.  Overall, FX swaps and currency swaps grew, and cross currency swaps grew sharply, while FX option volume nosedived.

Spot fell across the major currency pairs Euro 12.5%, Yen 12.5%, Swiss Franc by 13.6% with Sterling rising by 2.6% as the lead up to Brexit caused considerable repositioning in Sterling assets.  No surprise as the Chinese Renminbi rose 41% and became the 8th most traded currency pair.

Capital constraints, digestion of regulatory change in the US and impending global regulation, changes in traditional liquidity provision, scandals and market disruptions since the last survey in 2013 are the main causes of the drop in spot. Additionally, the impact of the SNB’s surprise move in 2015 dislocated active FX trading and had many prime brokers reevaluating  their risk considerations. Creating challenges for smaller and riskier trading shops and hedge funds in maintain FX prime brokerage probably moved some of the FX spot volume onto exchange trade FX futures.

The market structure in FX continues to change quickly with acceleration in the adoption of digital models for trading and analyzing data in the FX market at the same time as major changes in FX market making and liquidity provision which has impacted spot FX trading.



French effort to use Blockchain for SMEs could have relevance for emerging markets

The recent news that a French consortium is beginning work on building post-trade infrastructure for trading of SME stocks in Europe will be of great interest to market participants across the world. The consortium comprises of BNP Paribas Securities Services, Euronext, Société Générale, Caisse des Dépôts, Euroclear, S2iEM and Paris Europlace.

There have been several notable developments with regard to experiments and adoption of Blockchain and distributed ledger technology in the leading capital markets globally. However, the signficance of this particular announcement lies in the fact that it tries to address the needs of the a sector that usually struggles to obtain easy access to the capital markets. If successful, such a project could drastically reduce the time taken for post-trade operations, slash costs and generally make it easier for SMEs to raise funds.

In a recent Celent report, we had found that most of the leading global post-trade providers believed that it was still a little early to expect major changes due to Blockchain technology. While this may be true, the current development would be of a lot of interest to the emerging markets around the world. In several such countries, the cost of accessing capital markets is comparatively high and the technology is also often found lagging, as in the case of European SMEs. If the French effort becomes successful, it could pave the way for application of Blockchain technology to specific tasks in emerging markets, not just to enable SMEs to raise capital better, but to help the overall market to leapfrog in terms of modernizing the market infrastructure.

Regulators and market participants in emerging markets should now see Blockchain and distributed ledger technology as a relevant means for streamlining their trading infrastructure. To that end, it is also important that they encourage firms within their jurisdiction to experiment and adopt such technology for specific local applications and requirements, and not just wait to see how it evolves in mature markets in the next few years. 

Is this the best time for an event such as Brexit?

It is difficult to read financial news at present without coming across extensive coverage of the Brexit referendum in the UK and its possible impact. As part of the financial sector, capital markets could be at the forefront in terms of bearing the impact of any likely change. There are already widespread claims of how London could lose its position as the premier European financial center. Of special relevance is the advantage that London has due to the 'passporting' principle, which allows leading U.S. or Asian banks and other firms to access the Europan market without any restrictions. Certainly with regard to these firms, if the UK leaves the EU, US and Asian banks that have based their teams in London while serving the European market will have second thoughts about doing so. Different alternatives have been touted, including Paris, Frankfurt and even Dublin. Some believe that all of these cities, and some other European financial centers as well, would benefit from the departure of the leading global banks from London, but this could lead to fragmentation in the European financial industry and reduce the effectiveness and competitiveness of European firms. 
There are various views and opinions that have been expressed during the run-up to the referendum. Many of these hold water. But in my humble view, when it comes to competitiveness, if the departure of the UK from the EU does lead to a fragmentation of the European financial industry, then this is the best time for it to happen. Technology has today advanced to a level that to an outsider, there would be little tangible difference if a thousand people in a bank are based across four difference financial centers in Europe instead of being in one place they were earlier, namely, London. There would certainly be a one-off rise in cost due to such as move, but the industry should be able to take that in its stride. Furthermore, a more fragmented industry in Europe would also have the ability to address national and regional requirements better than a single leading financial center. So financial creativity and innovation might get a boost across Europe. One would expect that London would continue to be a leading financial center globally, but it might be forced to reinvent itself to continue to be relevant for global banks and financial firms from outside the UK. Therefore, as a neutral and a student of capital market technology trends, Brexit does not necessarily hold many fears and might even lead to some interesting outcomes. Whether people in the City of London or the rest of the UK or indeed Europe have the same view, is of course, another matter!

Benchmark manipulation and market surveillance

The CFTC has recently revealed the instant messages written by Citigroup traders related to benchmark manipulation. Having recently published a report on Market Surveillance industry trends and soon to publish another one on the leading vendors, this seemed quite relevant. Current surveillance systems, be it for trade or communications surveillance, use the latest technology to capture possible instances of market abuse or manipulation. The capabilities are far beyond what was available a few years ago, and are holistic and comprehensive in nature. But in the end, the system is only as good as the people using it. The recent revelations have put a question mark over not just the traders involved in the benchmark manipulation scandal, but also the management of some of the leading institutions. Some firms are now going to great lengths to monitor their traders, but this is not an end in itself. The industry culture has to be transformed. The next instance of manipulation will not be in the same place and firms would have to overcome the motivation to profit in order to ensure compliance. The rise in the levels of regulation in the last few years probably would play the part of a positive reinforcer in the decision-making process and help influence industry culture, but is not a guarantor of propriety.

The battle for the soul of exchange-based equity trading?

The recent statements by Nasdaq regarding the possible use of a trading delay by the proposed IEX Exchange puts the spotlight on a battle for supremacy not just between rival exchanges, but very different philosophies regarding what the ultimate role of exchanges in the global capital markets should be. The established exchanges, willingly or unwillingly, represent the status quo in terms of how exchanges should function. IEX on the other hand hopes to represent the interests of those trading participants who believe that they have been left behind in the race for speed in today's capital markets, especially the retail participants and the smaller buyside. It seems like an inevitable outcome in the aftermath of the global financial crisis, which has stoked the debate on economic inequality and the unfair advantage that a select group of trading participants have over others due to their advanced technological capabilities and use of highly sophisticated financial products. 
Getting back to the objections raised by Nasdaq over the SEC proposal that any delay of less than a millisecond could qualify as immediate, which would enable IEX to operate in the way it wants, there is certainly some substance in Nasdaq's argument. The SEC would have to come up with a solution that is acceptable to both sides, and does not leave it vulnerable to legal challenges. It is going to be an interesting couple of months for industry obervers as they follow the debate over the fairness and validity of the SEC proposal, and the decision on the IEX application.

Being smart with artificial intelligence in capital markets

Artificial Intelligence (AI) is the new buzzword to talk about on the street. Financial institutions need to embrace AI, as we have explained in our January report, or else they risk to lose competitiveness or be coded by the regulators more than they can do it themselves.

I am in NYC next week to share Celent’s view on AI for capital markets. A little preview for your here.

Today we are at a crossroad where data scientists have the computing power, the alternative mind-sets to search and the willingness to look for narrow AI solutions, not the wide AI brain that we should get to in 2030 according to experts. This enables vendors to come up with amazing solutions from Research Scaling with Natural Language Generation to Market Surveillance/Insider Trading with Machine Learning Natural Language Processing or even Virtual Traders via Deep Learning of technical analysis graphics traders look at to take decisions.

The amount of data available is another big driver for the rebirth of AI, and regulators are looking at ways of accessing that data and using it. This is borderline what my colleagues would call RegTech, and it’s coming.

Our Q2 agenda reflects our understanding that you want to know more about AI: we will share ideas on solutions for the buy side, for exchanges and for the sell side. But in the meantime I hope to bring back some cool ideas from the big apple, hopefully also from the secretive quants working in the dark Silicon Alleys.

Most of the vendors I have profiled are specialists’ boutiques, but the cost of such research is however so enormous that generalists are trying to productize their fundamental research for various sectors, from health to homeland security, including financial services in partnership with financial institutions.

This morning I woke up to great news that Microsoft is at the forefront of Deep Learning on voice, imagine what this could bring to Anti-Money Laundering or Insider Trading products.  The other news was that some top quants of Two Sigma just solved an MRI algo to predict heart disease, and I hope other great minds will, as most of them usually do, also give back to society by applying their amazing knowledge to such grand challenges.

Another year of stress

Global banks are facing another year where there will be two regulatory stress testing exercises through the course of 2016 – namely the two big ones, US CCAR and EU stress tests. These exercises have been executed over the past few years with great trepidation and strain. However, despite the progress made to date by institutions, regulatory standards continue to evolve towards “tests” becoming more difficult each year, with higher expectations around the process and its sub-components. The underlying paradigm is one of “looking under the hood” of the stress testing machinery to ensure that its underpinnings are sound. My latest report points to strategic considerations and recommendations for the future of stress testing operating models and the solutions. However, I would like to also point out a number of separate (but related) observations from another industry report. In the most recent BCBS progress report for the adoption of the Principles for effective risk data aggregation and risk reporting (BCBS239), the most significant challenges involves the following, where:
  • 57% of banks surveyed in their compliance progress are materially non-compliant with Principle 2, which requires data architecture and IT infrastructure to fully support risk data aggregation capabilities and risk reporting practices not only in normal times but also during times of stress or crisis.
  • 50% of banks reported themselves to be materially non-compliant with Principle 3, which is in their ability to generate accurate and reliable risk data – aggregated on a largely automated basis so as to minimize the probability of errors – to meet normal and stress/crisis reporting accuracy requirements.
  • 43% of the banks are materially non-compliant with Principle 6, to generate aggregate risk data to meet a broad range of on-demand, adhoc risk management reporting requests, including requests during stress/crisis situations, requests due to changing internal needs and requests to meet supervisory queries.
The numbers above are telling and symptomatic of how the industry is coordinating various strands of regulation, and the architectural strategies that underpin the delivery of these initiatives. In our report, one of the points we underline is the need for stress testing data governance and management practices to be reconciled (better yet, commonly shared) with data/outputs from other related initiatives; for risk data aggregation and reporting (BCBS239), but also to cover emerging regulations like Fundamental Review of the Trading Book (FRTB) and accounting for loss provisions (IFRS9). Net net: If architecture around data and applications are not fundamentally (re)designed and IT change programmes are not executed to actively address interdependencies between various strands of regulations, banks will face an uphill battle for future regulatory compliance, and efforts to develop more sophisticated capabilities will yield diminishing returns. The ‘what’ and ‘where’ of these pain points are perhaps more straightforward to identify, but the ‘how’ of solving it is more elusive. That will be the focus on our upcoming studies e.g. stress testing vendor solutions, risk appetite management initiatives, and risk technology strategies. Watch this space.

A profitable future for capital market firms?

I read a study by Broadridge and Institutional Investor this weekend that contemplates the future of capital markets. The two firms worked together to create a fascinating piece entitled Restructuring for Profitability. The study collected data from 150 equity analysts on their thoughts/opinions/predictions about investment banks. I also attended a panel sponsored by Broadridge that discussed the report’s findings with senior capital market professionals. The piece offers a very interesting perspective, through the lens of the views of an aggregated group of buyside and sellside equity analysts who spend their days assessing capital market firms. What I found especially interesting from the study was that none of the large banks globally will have RoE’s above their cost of equity capital in 2020:
  • The US was nearly there with a gap of 0.09%
  • Europe has an expected gap of 1.31%
  • Asia has an expected gap of 2.77%
The report is full of data, and some key points focused on regulation and where investment bank earnings will come from. Other findings include:
  • 61% of the analysts expect regulatory pressures on global securities firm to intensify between now and 2020. The breakdown on a regional level is even more telling with 75% believing regulation will increase in Asia, 67% expecting Europe regulation to increase and 39% expecting the US to increase. Perhaps getting Dodd-Frank and Volcker out of the way early will pay off!
  • The analysts are largely optimistic about growth rates with a uniformity of view that growth will be better to 2020 vs the 2010-2014 periods. The analysts are most optimistic about M&A/advisory services (growing at a 4.86% CAGR) and least optimistic about FICC trading growing at 0.20% CAGR.
The attempt to close the profitability gaps discussed above, according to the analysts, will come from cost-control and restructuring, rather than revenue growth or balance sheet management. This path will continue to include rationalization and disposing of business units. Moreover, the report indicates a strong belief that banks have underinvested in technology and process improvement, with analysts responding that over the last 5 years banks have not invested aggressively enough in new technology to improve efficiency (61% of the time in US and 66% of the time in Europe). In searching for profitability and investing more aggressively in platform reengineering and technology, a fascinating point was made by a senior banking manager during the panel discussion. He stated that when banks analyze their investment in technology, they need to consider the cost of lack of clarity on necessary capital required, given the general opaqueness around actual regulatory levels, and to add a factor for potential regulatory fines, into project costing analysis to ensure that banks are properly evaluating the project economics of major technology investments. With a realistic view toward the future of their industry, business lines, and impending regulation, senior capital market decision makers need to utilize this type of calculus to ensure they are investing in efficiency in a difficult revenue environment.