Big banks invest, smaller face squeeze in FX battle

By Naomi Tajitsu

LONDON (BestGrowthStock) – The battle among top banks for dominance of the $4 trillion a day FX market will be decided by their ability not only to offer rapid-fire pricing and razor- thin spreads, but also to adapt to tighter trading rules.

In interviews with Reuters, big FX banks said players with deeper pockets would continue to maintain and develop technology for their electronic trading platforms in 2011, while smaller ones would struggle to keep pace with such massive investment.

Consequently, smaller players may lose some market share gained through aggressive expansion in 2007-10, when the share of the top five banks slipped to 55 percent from 61 percent.

“Those institutions which have tried to go from being niche players to top five players will probably see that their investments are not paying off to the extent that they thought they were,” said Jeff Feig, global head of G10 foreign exchange at Citi (C.N: ).

Canadian bank BMO (BMO.TO: ), which raised its market share in the past year, acknowledged it could not compete with the bigger banks on investment. “Major FX banks are investing heavily and reinvigorating their teams to try and capture more volume market share and we won’t be trying to compete with that,” said Firas Askari, Managing Director and head of FX trading for Canada and London at BMO Capital Markets.

Instead it would instead concentrate on becoming a niche provider of Canadian dollar liquidity.

A Bank for International Settlements survey this week showed daily average trading volumes at the top banks have soared by up to 200 percent since 2007, suggesting major players are taking a bigger piece of the FX pie while smaller banks are pushed aside.

GROWTH IN ETRADE

Overall growth in the industry has been driven by electronic trading, whose volume has climbed since 2006 to comprise roughly 50 percent of the FX market this year, according to Greenwich Associates consultancy, which contributed to the BIS survey.

Citi, ranked the No. 4 FX bank by market share in Euromoney’s benchmark industry survey, said a rise in the electronic trading of swaps and growing interest in emerging markets boosted its FX business in 2010.

Deutsche and Barclays Capital, ranked by Euromoney as No. 1 and No. 3 respectively, both said electronic trading in options grew significantly after they launched fully automated trading services for such products this year.

The race to offer the most sophisticated products and the narrowest spreads via electronic platforms will remain intense as growing awareness of FX as a profitable asset class helps to drive volumes higher next year.

Industry analysts say higher volumes and volatility will make better risk management and transparency more important. Tighter trading rules, including new regulation on derivatives in the U.S. Dodd-Frank Act, will address this in 2011.

“Banks which can show their clients they can comply with the regulatory environment will be rewarded. It’s not just about who has the quickest prices and the best spreads,” said David Poole, chief operating officer at market researcher Client Knowledge.

“It’s about who has the best process too.”

One of the main areas where improving systems will be most vital is algorithmic trading — high-volume, automated trades designed to capitalize on the tiniest of market movements.

“Algo” trades accounted for 45 percent of transactions on electronic platform EBS in 2010, jumping from 28 percent three years ago, and some banks are seen struggling to keep investing the vast sums required to cope with growing demand for them.

But Client Knowledge’s Poole said their growing popularity meant success in the market would increasingly depend on how well players could handle high-frequency trades.

“Rather than being a niche activity by a few top banks and investors, it will be something that everyone will have to have the infrastructure to be able to deal with to act effectively in the market,” he said.

(Additional reporting by Neal Armstrong and Jessica Mortimer; Graphic by Vincent Flasseur; editing by Nigel Stephenson)

Big banks invest, smaller face squeeze in FX battle