Systems Trumping Humans In Foreign Exchange
The world is increasingly being shaped by computers, and nowhere is that more evident than in the financial space. Although much of the advanced algorithm action has taken place in the equities world, foreign-exchange trading is now experiencing a similar disruptive wave, with the industry replacing many of its foreign-exchange traders with computer platforms.
Allegations of collusion have kicked off intense regulatory scrutiny with about a dozen on-ongoing investigations exploring allegations that traders colluded to rig benchmarks. Replacing foreign-exchange traders with computer platforms serves several goals, including meeting client demand for greater transparency in pricing and transaction charges. The move is also likely to lower costs for customers and squeeze margins for banks.
"Foreign exchange traders are much like stock floor traders: a rapidly dying breed," observed Charles Geisst, author of Wall Street: A History and a finance professor at Manhattan College. "Once the banks realize they are costing them money, the positions will dwindle quickly."
According to a recent Bloomberg report, the investigations are accelerating a shift that was already underway. Approximately $5.3 trillion is traded on foreign exchange markets every day. Electronic trading comprised 66 percent of all currency transactions in 2013 up from 20 percent in 2001. This figure is set to jump to 76 percent within the next five years, according to Boston-based consulting firm Aite Group. Based on a study of Bank for International Settlements data, Aite predicted that 81 percent of spot trading – the buying and selling of currency for immediate delivery – will be done electronically by 2018.
"A good chunk of spot traders, maybe 30 percent to 40 percent of them, are at high risk of electronification eating their lunch," said Javier Paz, senior analyst at Aite.
In the modern era of computers and digital trading, forex trading has become less dependent on a physical exchange of currencies. Early computerized trading systems were not entirely reliable and lacked the ability to handle larger transactions, but recently a lot of technology from the equities world has been brought into the forex space.
The fact that most trading takes place away from exchanges protected jobs for a while, even while computer technology was eroding jobs in the equities space. Since clients lacked a central repository, they had to rely on traders and salesmen with knowledge of other clients' orders for guidance about the direction of rates. In fact, research shows that order flow is one of the few reliable predictors of future pricing, and traders can turn that knowledge into profit. The current regulatory inquiry may, however, lead to the market being restructured, in which case banks may lose this advantage.
Major currency-trading banks such as Deutsche Bank, Citigroup, Barclays, and UBS have all seen their ranks of spot traders reduced. Some 21 employees have been fired or suspended due to the investigations and others are simply leaving of their own accord. Some banks have banned dealers from using multiparty chat rooms.
Even before this latest regulatory matter, banks' income from foreign exchange was hampered by a decrease in market volatility as banks responded to Europe's sovereign-debt crisis by providing easy liquidity to help stabilize markets.
Banks are also looking toward electronic platforms as way to recoup money lost to regulatory measures. A new ruling from the Basel Committee on Banking Supervision imposes additional charges on certain foreign-exchange derivatives, for example.
London-based analyst firm Sanford Bernstein predicts that the shift toward electronic-based trading will concentrate the market to a handful of largest players, as competitors with a lower market share are outmaneuvered. Firms may also transition to an equities sales-trader model, where salespeople provide market information and handle orders.