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Emerging regulations under Dodd-Frank’s execution and clearing mandates and the higher capital requirement ratios under Basel, are driving huge changes in the business models for investment banks.

Under Dodd Frank, following the introduction of SEFs, banks will be prohibited from trading directly with clients on a bilateral basis in standardised swaps. Instead, bank Single-Dealer Platforms will provide SEF aggregation and routing capabilities of client orders through to one of the now 17 registered SEFs.

Whilst for capital-intensive markets like credits, banks are moving away from providing costly inventory based principal trading and moving to an agency model such as UBS PIN. In these markets, the value proposition for the bank shifts downstream, where the bank will provide value added smart order routing (SOR), clearing and collateral management and optimization services, to offset the reduction in trading profits from these products.

But what about FX?  Lightly regulated (in comparison), and by far the largest and most liquid of all the global markets, with latest BIS Triennial data showing that daily volumes have grown 34% to reach $5,345 bln/day.

Is there still money to be made here, and if so by whom, and what’s the competition like?

Looking at the global FX market a little closer, and using the Euromoney 2013 FX polls as a guide, we can split the reporting dealer banks who are active in this market into two broad categories:

Global Flow Monsters: Top global bank is Deutsche, who alone accounts for some 16%, with the top five accounting for 57% of the market, and the top ten accounting for nearly 89%.

These firms are characterised by their huge investment budgets, large development teams and a desire to build everything in-house. They have highly sophisticated etrading platforms and the ability to service all client segments globally. It is not uncommon for a new multi-asset class SDP project to take 2-3yrs and cost well in excess of $100mln, depending on the ambitious nature of the project (the latest 2-3yr re-build being UBS with Neo)

EuroMoney FX Ranking showing market share of each group of banks

In terms of costs of an SDP, the chart below from consultancy GreySpark shows the cost of a new SDP project for a global top tier bank at something like $120mln, having risen threefold since 2007.

Cost of building an SDP by leading banks
(GreySpark research as shown in EuroMoney article)

The $120-130mln for a new SDP project for a global top-tier bank sounds about right.

The research firm Coalition, tracks the FICC revenues of the top ten Global investment banks, and for 2012, their figures show that FX G10 revenues were down some 22%.

So, for the Global Flow Monsters, it’s costing them a fortune to develop new platforms, and their overall G10 FX revenues are falling!

However, here at Caplin, we have a number of Single-Dealer Plaform projects with regional banks that have connected to all back-end pricing and risk systems, and gone live with corporate clients in around 6mths, for well under 10pct, probably closer to 5% of what a global top-tier bank would spend, which is why the business case for SDPs remains strong.

Super Regional Banks: The next 40 biggest FX banks account for under 20% of the market. Typically, these banks are dominant regional players with strong local client franchises, and deep expertise in particular regional FX markets. They will typically be servicing a high number of corporate clients, and providing good solid workflow solutions for them, and integration with transaction banking systems.

Many regional banks are seeing an influx of etrading talent from the global flow monsters, who quickly set about creating or upgrading their etrading capability, so that they can defend and grow their client franchise.

These banks, whilst they have big technical teams, they are increasingly looking to buy best of breed solutions to create their platform, rather than build everything in-house. A decent FX SDP project being live in under a year using best of breed vendor technology for about $20-30mln.

The chart below is very interesting, as it shows the change in market share of each of the bank groups from the above chart. As can be seen, the top-tier global ‘flow monsters’ have been investing hugely in their platforms, yet they have lost market share. The big winners being the regional banks, growing market share at a fraction of the cost.

EuroMoney FX Ranking showing change in market share of each group of banks (2008-13)

Filed under: FX, Paul Blank, Single-Dealer Platforms, Web trading technology |