Bank Pools Sink Rivals Amid Record Low Volatility: Currencies

Banks are harnessing record-low currency volatility as they seize a bigger share of the $5.3 trillion-a-day foreign-exchange market, taking business from their electronic-platform competitors.

Average daily volumes on ICAP Plc’s EBS platform and two of Thomson Reuters Corp.’s systems fell to $312 billion in June from $399 billion a year earlier, data compiled by Bloomberg show. Interdealer brokers’ share of trading dropped to 39 percent in 2013 from at least as high as 63 percent in the late 1990s as major banks conduct more business internally, according to the Bank for International Settlements.

Banks have little reason to pay the extra expense associated with routing trades through outside platforms at a time when a drop in volatility is already squeezing profits. The concern is that currency markets will become more opaque and less efficient, said Michael O’Brien, director of global trading at Boston-based mutual-fund company Eaton Vance Corp.

“I don’t want a handful of banks or one or two banks to internalize everything to the extent that that’s the only place where liquidity is,” O’Brien said in a July 14 phone interview. Eaton Vance manages $293.6 billion.

The discussion about transparency comes as officials are already investigating banks for possibly manipulating benchmark currency rates.

Volatility Tumbles

Price fluctuations in currencies fell to a record this year, with JPMorgan Chase & Co.’s Global FX Volatility Index dropping to 5.3 percent on July 3 from last year’s high of 11.8 percent. The drop in volatility is a by-product of the unprecedented amount of cash that central banks have pumped into financial markets in recent years.

Banks often hold more foreign-exchange assets on their books when there’s lower volatility, giving them more time to find a buyer without having to go to other venues. That internalization can cut costs for everyone involved, said Kevin McPartland, head of market structure for research firm Greenwich Associates in Stamford, Connecticut.

“It saves money for everybody if a bank can match internally and nobody is paying fees on execution,” McPartland said July 2 in a phone interview.

EBS and two Thomson Reuters venues account for a combined 40 percent of the $1 trillion traded daily over such platforms, according to an Aite Group LLC report last year. A market operated by Bloomberg LP, the parent company of Bloomberg News, accounted for 11 percent, according to the report.

The average daily volume traded on Tradebook’s foreign-exchange platform rose 95 percent in the second quarter from a year earlier in notional terms, according to Vera Newhouse, a spokeswoman for Bloomberg.

Trading Volumes

In ICAP Plc’s earnings call in May, Group Finance Director Iain Torrens said his firm’s EBS Market has suffered from reduced volatility and the rise in bank internalization. The big banks are keeping as much as about 90 percent of customer orders, he said.

“I hope, of course, there will be an increase in volatility,” Torrens said according to a Bloomberg transcript of the call. Guy Taylor, a spokesman for EBS, didn’t respond to requests for comment.

Trading volumes have dropped at banks as well as third-party party platforms amid the plunge in price swings. Currency-trading sales at the 10 largest global banks declined 9 percent in 2013, according to industry analytics firm Coalition Ltd.

“Everybody would just prefer the markets just start moving again,” McPartland said.

Dark Pools

Bank trading platforms are sometimes referred to as liquidity pools, which are trading venues for buyers and sellers of an asset. Dark pools in the equity market are so named because bids and offers are unavailable to the public. One way they differ in foreign-exchange is that banks generally hold a currency on their books for a period of time.

“There’s a lot of opaqueness about exactly how the banks are coming up with the prices they’re filling and what orders are being filled,” Ron Leven, head of foreign-exchange pre-trade strategy at Thomson Reuters in New York, said July 15 in a phone interview. “That’s the nature of the beast.”

Officials around the world are questioning transparency in the currency market. At least a dozen regulators on three continents are investigating whether traders in the largest financial market colluded with counterparts at other firms to manipulate benchmark currency rates.

Benchmark Probe

U.K. prosecutors are preparing to open a criminal investigation into alleged manipulation of foreign-exchange benchmarks, a person with knowledge of the matter said. The Serious Fraud Office could announce the investigation as soon as this week, the person said, asking not to be named because the move isn’t public.

In the stock market, New York Attorney General Eric Schneiderman is scrutinizing dark pools. His complaint against Barclays Plc includes the allegation that the London-based bank hoarded trades at the expense of brokerage clients who may have gotten better deals on other venues.

“These are serious charges that allege a grave failure to live up to our values and to the culture at Barclays which we are trying to create,” Chief Executive Antony Jenkins said in a memo last month to employees. “If there has been wrongdoing we will address it quickly and decisively.” Barclays didn’t respond to several requests for comment.

Officials haven’t accused banks of wrongdoing in relation to their currency platforms or internal pools.

‘Traditional Venues’

Citigroup Inc., based in New York, is the biggest dealer in the foreign-exchange market based on Euromoney Institutional Investor Plc data, followed by Deutsche Bank AG in Frankfurt and London’s Barclays.

As banks “have effectively become deep liquidity pools, their need to manage inventory via traditional inter-dealer venues is much reduced,” according to a December report by the BIS in Basel, Switzerland.

Scott Helfman, a spokesman for Citigroup, and Oksana Poltavets, a spokeswoman for Deutsche Bank, declined to comment.

“It’s always in the banks’ interest to gravitate business to their own platform because then they capture both sides of the spread,” Thomson Reuters’s Leven said, referring to the difference between bid and ask prices. “We’re not going to see the vast majority of business all moving onto single-bank platforms.”

Bloomberg competes with information providers including Thomson Reuters.

Fair Price

Keeping more of the banks’ customer orders internal makes it harder for traders to know if they’re getting a fair price, according to Dmitri Galinov, chief executive officer in New York at FastMatch Inc., an electronic-trading platform.

“How can somebody claim that they have the best prices in the market where 80 percent of the trades nobody knows about?” Galinov said last month in a phone interview. He was previously head of liquidity strategy at Credit Suisse Group AG, where he oversaw a dark pool. In the euro, “there is enough trades there. But emerging-market pairs, how do you know the price is accurate?”

The currency market’s structure was changing even before it was beset by the latest drop in volatility. Dealing banks have been “increasingly dissatisfied” with existing trading platforms over what they see as outmoded technology and favoritism of high-frequency trading companies, according to Aite Group.

Besides saving money on transaction costs, internalization also leaves less evidence of trades in the market for competitors to sniff out, said Isaac Lieberman, founder and chief executive officer of quantitative hedge fund Aston Capital Management LLC.

Lieberman previously was head of algorithmic trading and electronic FX options trading at JPMorgan Chase.

“This works well in a low-vol market,” Lieberman said July 2 in a phone interview from New York. “Internalization takes liquidity away from market venues which reduces opportunities for other market participants.”

To contact the reporters on this story: John Detrixhe in New York at jdetrixhe1@bloomberg.net; Sam Mamudi in New York at smamudi@bloomberg.net

To contact the editors responsible for this story: Dave Liedtka at dliedtka@bloomberg.net Paul Armstrong

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