EVOLUTION OF THE FX MARKET

Will Robbins, Head of Asia, IS Prime Lt. recently gave a presentation at the large scale forum on “Potential of Derivatives Market In Cambodia‘s Financial Sector,” co-organized by the Securities and Exchange Commission of Cambodia (SECC)  and Cambodian Derivatives Exchange Co., Ltd. (CDX), and presided over by SECC’s Director General H.E. Mr. Sou Socheat.

 

“Derivative” is a mathematical term that refers to a variable which has been derived from another  variable. A foreign exchange derivative is a financial derivative whose payoff depends on the foreign exchange rates of two or more currencies. These

instruments are commonly called FX and used for currency speculation and arbitrage or for hedging foreign exchange risk.

 

Looking at the evolution of the FX market, access to the FX market has increased since the 1980s, when strict credit guidelines permitted only banks, funds, CTAs, large corporations and big investors to trade. The emergence of online retail brokers in the early 2000s and the explosion in technology has increased market development and smaller investor participation (noting OTC Spot FX volumes have risen from USD1.2tn in the 1990s, mostly voice trading, to over USD5.5tn today, with over 60% of all trades performed electronically).

 

The easy deployment of platforms, streamlined trading, increased transparency and lower costs has provided the small investor with an unrivalled choice of brokers to trade with. Price, quality of execution, slippage, STP, and service - these are all important factors to consider when picking an FX broker, especially as not all brokers are equal.

 

“The best brokers will have strong partners, particularly in terms of liquidity, risk and technology.”

 

Access to Credit has Changed

 

As FX is traded on a bilateral basis, credit and clearing are essential. Prime Brokers have been the main intermediaries.

Post GFC (2008), significant regulatory changes and market events have severely impacted how Prime Brokers operate.

 

• Reductions in leverage and increased capital requirements

 

• Reviews of credit and counterparty exposure. Clients now assessed based on their ROA.

 

• Reduced appetite for more risky, less capitalized clients (especially retail brokers)

 

• Many banks have exited the FX PB business (e.g. Credit Suisse), whereas others are “offboarding” clients below a certain threshold of assets (usually ~USD25m of excess net capital).

 

This has left many clients with limited options for credit intermediation, driving the development of the “Prime of Prime.”

 

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