Forex contends with great expectations

The foreign exchange industry is set for a shake-out next year as re-pricing of risk forces change in the make-up of the industry.

The diversity of speakers at the FX Week Europe Congress last Tuesday ensured concerns from all angles of the business were tackled. Opening the event with a seemingly bleak outlook was Paul Fisher, head of the foreign exchange and reserve management division at the Bank of England. He highlighted that, with hedge funds taking a battering this year and retail traders, particularly in Japan, burnt by the protracted spike in volatility, growth in FX volumes will slow next year.

Slow doesn't equate retract though, as Mark Warms, general manager for Europe at FXall, noted. He gave the example of an e-commerce colleague working for a bank who said he'd never seen such close ties between the bank's chief executive and its head of FX. The sharp rise in electronic trading over the past few years, accredited in part to CLS, meant margins on FX liquidity provision became all but completely eroded. Nevertheless, FX continues to be a profitable business, not least because of its traditional ancillary nature and the improved use of technology.

However, the past three months of sometimes abysmal, sometimes very good liquidity described by dealers at the event highlighted the need to have the technology to internalise flow. This is particularly true as some hedge funds that actively made markets have withdrawn as the cost/benefits went against them. In fact, Marco Pelizzoli, global co-head of global FX e-solutions at Bank of America, said that, after internal discussions, his bank found there's a better form of liquidity internally than externally. "It's more consistent," he said.

The consensus of banks at the event was that there will be consolidation among FX banks in the next 18 months, focused on those that have already invested heavily in technology and have the management buy-in to keep enhancing it. Meanwhile, regional dealers will become niche players, forming bilateral relationships with the major dealers.

But when asked whether the electronic market will ever return to pre-August 2007 days, speakers said the jury's still out.

Meanwhile, for technology vendors the markets couldn't be better, as long as they evolve to meet the changing needs of dealers. As Fisher said, the market is moving to more appropriately price risk, which will lead to new ways of trading FX. This will see the emergence of new platforms that, like ECNs for hedge funds, will support the development.