The grip of the world’s biggest banks on the $5.3-trillion-a-day currency market is under attack.
After the Swiss National Bank stunned the world in January by abandoning its price cap on the franc, some banks sought to reduce their losses by trying to renege on transactions. Dealers including Bank of America Corp., Barclays Plc and Goldman Sachs Group Inc. approached customers about changing some trades, according to people familiar with the discussions.
The banks’ attempts to reopen deals present their rivals -- electronic trading venues and established exchanges -- with a new argument in their battle for market share. From Chicago to Stockholm, foreign-exchange operators are making an invigorated sales pitch: Do business through us rather than dealers who can cancel or alter your trades after they’ve been executed.
“There’s not really a middle man,” said Kevin McPartland, an analyst at Greenwich Associates. “Foreign exchange is still over-the-counter, so you’re still mostly dealing one-to-one in your trades, which I guess is why we were in this state of renegotiation.”
Buying and selling currencies commonly takes place between a bank and its customer through over-the-counter trading.
OTC currency trading is largely unregulated, giving the banks a lot of freedom in how they operate. The big dealers will quote different prices depending on their relationship with the customer. They will also tweak prices according to the credit quality or sophistication of the client seeking to trade. And, as some companies discovered in the aftermath of the SNB’s action on Jan. 15, banks can reopen transactions after they have taken place.
Some foreign-exchange trading takes place on third-party venues run by electronic systems, established exchanges and inter-dealer brokers. Thomson Reuters Corp.’s venues process 30 percent of electronic currency trades, according to consulting firm Aite Group LLC. CME Group Inc. and EBS, which is owned by ICAP Plc, each handle about 10 percent.
The third-party platforms should operate with fewer conflicts of interest. They typically publish a standard rule book that everyone using their market must follow.
Bloomberg LP, the parent company of this news organization, also has a trading platform.
CME has presented as a virtue the fact that it doesn’t reopen trades after they have been executed. The Chicago-based market operator had its own turbulence on Jan. 15. It had to halt trading at times when the franc surged as much as 41 percent against the euro.
“We had safety, transparency and certainty,” said Sean Tully, senior managing director at CME. The markets operator didn’t reject any trades, and only paused trading while it waited for liquidity to return, he said. The firm has since amended its rules for trading during extraordinary events.
The company’s currency futures are taking market share from OTC venues, the exchange said during a February conference call.
Banks have reason to take the exchanges seriously because they won the argument last time. Following the 2008 financial crisis, G-20 leaders meeting in Pittsburgh decided that OTC derivatives should trade on exchanges or other electronic platforms wherever possible.
Central counterparties for clearing were seen as a way to reduce risk following the crisis, during which bank-to-bank dealings nearly toppled the financial system. CCPs don’t take a position on trades and stand between buyers and sellers.
“Jan. 15 increased the interest in central counterparty clearing in the foreign-exchange space,” said Magnus Billing, senior vice president of Nasdaq OMX Stockholm. “They’re looking for that, for someone in between the client and the broker to take the risk out.”
Bank of America, Barclays and Goldman Sachs contacted customers after the SNB decision, asking to discuss the rates they’d traded on, according to people with knowledge of the discussions. Bank of America continued to contact clients the next day, according to a document seen by Bloomberg.
Barclays’ losses didn’t have a material impact on the bank’s financial results, and the lender was able to fulfill all spot Swiss currency trades, a person familiar with the matter said in January, asking not to be identified because the matter was private.
Spokesmen for Bank of America, Barclays and Goldman Sachs declined to comment on their talks with clients.
Whenever a party complains about a trade being canceled or adjusted, it’s likely to get regulators’ attention, said Chris Concannon, chief executive officer of Bats Global Markets Inc.
“These events continue a trend where regulators, participants and end users continue to find the characteristics of an exchange-traded instrument as being attractive,” said Concannon, whose company bought the Hotspot FX currencies platform from KCG Holdings Inc. this year.
Banks are reluctant to give up their hold on currencies. If they did, trading could become more expensive and more difficult. A major market structure change may not happen without regulators getting involved.
While the foreign-exchange market doesn’t need a complete overhaul, the fallout from the franc cap’s removal demonstrates the need for central-limit order books, said Darryl Hooker, head of EBS Market. Such order books match customers according to price on a first-come, first-served basis. Exchanges typically use the same system for their stock markets.
EBS had one “mistrade” on its platform on Jan. 15. It put the counterparties in touch with each other to resolve the error, according to a statement on its website.
“Exchanges may have rules and/or speed bumps in place, which can result in blackouts,” Hooker said. “We had no disruption of service at all on the 15th of January.”