AFME LIQUIDITY CONFERENCE FX MARKET STRUCTURE 25 FEBRUARY 2015 FINANCIAL SERVICES
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Overview The FX market has evolved into a highly sophisticated ecosystem Rapid volume growth and electronification Specialized roles and a wide range of actors Many different ways to access pricing and execution However a number of pressure points are emerging Economic pressures Focus on market conduct Focus on market structure This raises questions and challenges for all FX market participants Strategic questions over where to compete in the value chain, and where to share costs Questions over where to innovate new execution models, new collaborations A need for new policies and internationally coordinated frameworks to govern conduct A need for the industry to proactively shape the next phase of market structure change 2
FX trading volumes underwent a step change in the mid-2000s as the market re-ordered around electronic platforms and infrastructure upgrades Overall electronic vs. voice executed turnover $ BN Phase I Gradual adoption Phase II Rise of Multi Dealer Platforms and CLS Phase III Rapid electronification Phase IV E trading ecosystem 5,345 774 1 100% 1,182 ~95% 1,527 ~90% 1,239 ~85% 1,934 ~35% ~65% 3,324 ~45% ~55% 3,971 ~60% ~40% ~65% ~35% 1992 1995 1998 2001 2004 2007 2010 2013 EBS launched (1992) FX Connect launched Autobahn launched as execution tool (1996) Launch of Currenex (1999), FXall (2001), Hotspot (2002) CLS starts operations (2002) SDP development by banks; BARX launched (2001) Dealer SDP upgrades (additional functionality, products) Tier-2 bank SDP roll-outs Increasing use of algorithms and automated trading 1. Total FX turnover for Spot, Forwards and FX swaps contracts for 1992 Source: BIS, FRBNY FXC, BoE FXJSC, Oliver Wyman estimates 3
Volume growth over recent years has been driven by trades between financial participants, with roughly two trades per end user transaction BIS stated global FX daily turnover $ BN 6,000 5,000 4,000 3,000 2,000 1,000 0 1,934 53% 33% 14% 2004 3,324 42% 40% 18% 2007 Between reporting dealers 3,971 39% 48% 13% 2010 Other financial participants to reporting dealers Non-financial participants to reporting dealers 5,345 39% 53% 9% 2013 Oliver Wyman estimated break down of volumes by counterparty type 2013 Participant type End users with indirect access Share of turnover ~5% Large corporates 10 15% Buy side FX hedgers 10 15% Central banks ~1% FX traders ~10% Banks ~55 60% End user flow 1 $1.7 1.8 TN 30 32% Financial flow $3.9 TN 68 70% 1. Includes Oliver Wyman estimate of end-user flow to BIS non-reporting dealers and specialist distributors which is not included in BIS survey figures 2. Total merchandise trade, exports, US dollar at current prices Source: BIS, WTO 4
Voice SDP Voice SDP The market structure that has evolved to support end users is complex, with a number of key developments over recent years Six key trends in recent FX market structure evolution 1 Shift in mix of client execution flow towards MDPs FX traders and liquidity providers 1 End users 2 Rise of non bank risk takers and algorithmic trading 3 Growth in specialist providers Specialist distributors MDPs Other dealers 4 Pressure on non tier 1 dealers and banks 5 High levels of internalisation in core businesses Prime Broking Tier 1 dealers Electronic platforms 6 Lower volumes on interdealer platforms Voice Inter dealer brokers Price taker relationship Varying price maker/taker relationship 5
1. Client execution flow mix Multi-dealer platforms have grown 3 4 times faster than other channels Client volume executed through voice, single and multi-dealer platforms 1 % of ADV 100% Turnover CAGR (2008 13) Voice share down 16% 2008 13 Share has declined as flow products migrate to e- channels Still dominant in more complex/less liquid products 80% 60% Voice 6% Single-dealer platforms (SDP) flat share since 2008 Have retained share overall as banks continue to invest in functionality Growing competition between SDP providers top 5 share 62% in 2013 vs. 85% in 2006 40% SDP 12% Multi-dealer platforms (MDP) share up 16% since 2008 Growing competition between MDP providers top 5 share 77% in 2013 vs. 91% in 2006 20% 0% 2008 2009 2010 2011 2012 2013 MDP FX trader focus MDP end user focus 31% 48% FX trader focused 9% increase in share from 2008 Examples: FXAll, Currenex, Hotspot Offer low latency and colocation FX end user focused 7% increase in share from 2008 Examples: FX Connect, 360T Primarily target end users 1. Based on BoE FXJSC sample, and excluding those volumes executed via interdealer broking platforms Source: BoE FXJSC, Euromoney, Oliver Wyman estimates applying Euromoney market shares to BoE FXJSC data 6
2. Non-bank risk takers There are a range of different types of non-bank liquidity provider Evolution of proprietary trading in FX Overview of non-bank liquidity providers (NBLP) 1. Rise of the non-bank liquidity provider Porting of technology and risk management techniques from the equities markets to FX Initially focused on entry into e-idb channels to facilitate risk recycle from the large dealers 2. Beginning of High Frequency Trading Rapid decrease in latency on platforms coupled with high messaging capacity Migration of futures focused NBLPs to FX Rise of taking strategies and rebalance from pure market making 3. FX as an asset class Platforms emerge dedicated to customer segments Entrance by hedge funds and NBLPs focused on systematic strategies (rather than latency) Access now democratic as platforms open to non-dealer channels NBLPs now have ~8 13% share of spot volumes Source: Oliver Wyman estimates Strategy Market maker Speculative strategies Aggressive takers Systematic strategies Description Automated market making in a small number of highly liquid pairs Low latency critical for risk management Opportunistic trading algorithms geared towards taking advantage of market conditions as they arise Focus on low latency price arbitrage opportunities (on individual platforms or across platforms) Makers and takers characterised by less latency sensitivities Significantly lower messaging volume and longer holding periods Est. % of NBLP volume (spot) ~30 35% ~30 35% ~25 30% ~5 10% 7
3. Specialist distributors Specialist distributor transaction volume has doubled since 2007 to ~$0.2 TN Estimated specialist distributor volume transacted ADV, $ TN Example specialist distributor business models Model Proposition/Offering Description CAGR ~10 15% ~0.2 Traditional MTO 1 Transactional FX products Travel cards White-label offering Retail FX trading platform Main focus on retail, private, business segments More sophisticated products, competitive pricing Also provide white-label solution to distribution partners to expand reach ~0.1 ~80% ~80% Corporate P2P players Spot FX White-label offering Spot FX E-commerce services Peer-to-peer FX offering, also for business users Transparent and straightforward pricing (typically fee-based) Disruptive model, infringing bank/mto space ~20% ~20% Retail M-payment providers/teleco m partnerships Digital wallet Mobile payments platform Partnerships with banks (e.g. La Caixa) and card networks (e.g. Visa) 2007 2013 1. Money Transfer Organisation Source: BIS, Oliver Wyman proprietary data and analysis 8
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 4. Other dealers The market share of the top-10 dealers has remained relatively stable post-crisis, following a period of consolidation over 2001-7 Market share of client turnover across all FX products by dealer ranking % 37% 10% 17% 36% 26% 24% 23% 12% 17% 19% 19% 44% 13% 44% 13% 45% 15% 13% 11% 12% 12% 13% 12% 12% 12% 13% 23% 49% 11% 22% 55% 8% 8% 8% 20% 18% 18% 61% 61% 62% 10% 23% 25% 24% 22% 55% 11% 52% 9% 55% 9% 57% Turnover 1 CAGR (2001 13) Others 6% Next 11 15 dealers Next 6 10 dealers Top 1 5 dealers 16% 19% 21% Perspectives The larger dealers share of client volumes increased substantially over 2001 6, movements have been more modest in recent years Business models for mid-sized and smaller dealers have remain more pressured Large fixed cost base and flat revenues pressuring economics Harder to extract value from market making Pressure from specialists on franchise flows Overall 17% 1. Based on BIS reporting dealer volumes transacted with non-financial participants and other financial participants Source: Euromoney, BIS, Oliver Wyman estimates based on using Euromoney market shares and BIS global turnover data 9
5. Internalisation Internalisation levels differ widely across instruments within FX Product Client flow matching 1 (estimated based on BIS data) Oliver Wyman trend view Comments Spot ~70% More efficient matching engines have increased dealer ability to match client flows Forwards ~65% Concentration of market share has increased naturally offsetting clients flows to dealers Lower matching due to tenor, start date differences and prevalence of bespoke contracts FX swaps ~20% Client flow needs to be actively risk managed through inter-dealer hedging Additional inter-dealer flow due to overall liquidity/risk management needs of banks Options Not meaningful given inter dealer hedging is primarily through delta 1 products with much lower inter dealer flow in higher order greeks Looking only as BIS option volume data indicates low proportion of inter-dealer hedging Does not capture delta hedging flows Typically risk is warehoused due to complex, bespoke option structures 1. Defined as 1 (Inter-dealer hedging transaction volume/total client transaction volume) Source: Oliver Wyman estimates based on BIS FX Triennial Survey 2013 10
6. Interdealer platforms The market share of traditional electronic interdealer broker venues has declined as new execution platforms emerged Share of EBS and Reuters in overall spot FX turnover % of global ADV Share¹ 59% 69% 72% 51% 55% 53% 38% 36% 33% Aggregate IDB volumes have declined on an absolute basis 30% 25% 20% 15% 25% 26% 20% 20% 19% 17% 14% 13% 13% The share of Reuters and EBS of reported BIS spot trades has halved since 2006 10% 5% 0% 2006 2007 2008 2009 2010 2011 2012 2013 Q1 2014 Emergence and growth of non bank liquidity providers (e.g. HFTs) along with MDP growth has provided impetus to trade smaller sizes across venues Spot ADV $ BN Reuters EBS CAGR 2006 13 Reuters 91 117 118 116 140 151 128 119 114 4% New venues with latency floors have emerged for risk management EBS 142 182 214 134 152 159 112 106 87-4% 1. Share of spot traded between BIS reporting dealers, Source: Celent, BIS, Company websites 11
Looking ahead we expect continued change as the market adjusts to competitive and regulatory pressures Theme Key elements 1 Focus on conduct Defining acceptable behaviour for sales and traders Determining appropriate pricing levels for different channels/clients 2 3 Market regulation Implementation of mandated clearing, margining, SEF/OTF execution and trade reporting for various (non-spot) products New funding and operational costs Economic pressures Bank-wide pressures on cost, balance sheet and risk capacity Continued competition from non-bank distributors, market makers and technology providers 4 Focus on market structure Focus on concentration, market stability and tail risks Concerns around benchmarks and reference prices Debate around the future role of agency models 12
This raises questions and challenges for all FX market participants Strategic questions over where to compete in the value chain, and where to share costs Questions over where to innovate new execution models, new collaborations A need for new policies and internationally coordinated frameworks to govern conduct A need for the industry to proactively shape the next phase of market structure change 13
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