All trends play into Citi's hands, says Bindler, as bank crowned overall winner

The year 2016 has been a bit of a shocker. It was a time during which tail scenarios became a reality and the impossible became possible, providing currency markets with plenty to be excited about, albeit not in a way anyone expected.

Former reality TV star and now Republican president-elect Donald Trump will be sworn into office in January. Britain is in the throes of a messy divorce from Europe, which continues to teeter on the edge of turmoil. Meanwhile, in foreign exchange markets, sharp gapping exchange rate swings became normal and a non-bank liquidity provider (NBLP) made it into the list of top 10 market-makers by volume.

"The market has changed. The gapping moves we've seen this year have borne out the market's worries about liquidity and they are witness to the fact that the market structure has changed. But having said that, this year liquidity in G10 is somewhat better than last year, and depth of liquidity has picked up as well," says James Bindler, global head of G10 FX at Citi, which won Best Bank for FX Overall, as well as 10 additional titles (listed at the end of this article), at the 2016 FX Week Best Banks Awards.

Concerns about liquidity picked up sharply last year, when the Swiss National Bank's (SNB) move in EUR/CHF (according to one bank, an 86 standard deviation price swing) fundamentally changed the way markets operate.

We are an established institution with a client diversity that allows us to access client segments that alternative liquidity providers will struggle to reach
James Bindler, Citi

On top of that, regulations hitting banks have been chipping away at their ability to warehouse risk for years, while the market share of second-tier banks has been dropping since the financial crisis. This drop means the secondary market that used to be there has been replaced by what Bindler calls HFT shops, which provide liquidity in daylight hours.

While acknowledging a number of large NBLPs have morphed into market-makers, he says that in general, this segment is not engaged in periods of low activity, they are not committed to price-making 24/7 and they don't have order books.

"Both the macro environment and regulatory and market structure changes play into Citi's hands, because both complexity and costs are rising. We are an established institution with a client diversity that allows us to access client segments that alternative liquidity providers will struggle to reach. We also have the breadth of product offering – something that will remain largely out of reach of NBLPs," he adds.

The credit challenge

This is very true, especially as non-bank players rely entirely on prime brokers to gain access to the market. Citi is one of a handful of credit intermediaries that actually facilitate a rise in competition from NBLPs, but mostly just in spot markets.

"We continue to be active in the NBLP space, but our goal is to have a diversified portfolio. Our largest growth area was the macro hedge fund universe. We continue to see top-line growth, and both overall revenues and volumes increased, but we want to make sure we have the right client - a decision in which return-on-capital plays a big role," says Sanjay Madgavkar, global head of FX prime brokerage (PB) at Citi.

We have invested in the business and we have managed to end the year with profits up
Sanjay Madgavkar, Citi

But, just like on the trading side, prime brokers turned towards profitability, and away from volumes and market share.

"In 2016, we wanted to grow the business, at the same time as making sure we have a balanced and diversified client portfolio. Going forward, we will continue to analyse our client mix and make sure the fit is appropriate, like any good business would do," Madgavkar says.

Sanjay Madgavkar

"We have invested in the business and we have managed to end the year with profits up. In fact, 2016 was one of the most successful years we've ever had on the PB side," he adds.

Prices for credit are likely to keep rising across the industry. Many argue that pre-SNB, credit was excessively cheap and the adjustment in price in the last 22 months has been a normalisation process, rather than anything else. This will continue, reflecting heavier regulatory burdens such as capital rules and margin rules, as well as rising transaction costs, including utility fees like settlement and other input costs.

"Having said that, I don't expect large price jumps. I think it's a more gradual process," notes Madgavkar.

As access to prime brokers and markets has become more expensive and difficult, the search for alternatives began in earnest. Clearing is at the top of the agenda, despite the lack of regulatory mandates, as the economics have changed.

"Clearing has certainly increased in the interbank space, but I don't think the market is set up for client clearing just yet. The PB model is a full-service offering, and while it's quite clear that interbank clearing will grow, I don't expect a major shift away from the PB model on the client side," says Madgavkar.

Clients' cost pressures are real

Rising costs and diminishing returns are forcing both institutional and corporate clients to change their behaviour in other ways too. Macro hedge funds are struggling to generate returns, the asset management industry continues to consolidate, pension funds and sovereign wealth funds are trying to internalise as much flow as possible, and corporates are reorganising treasuries and have reassessed their approach to risk.

"Cost pressures continue on both customers and the sell-side overall, and the flat yield curve is forcing investors to look for more leverage and potentially more risk in a bid to earn returns," says Brian McCappin, the head of institutional sales at Citi.

Heightened volatility, especially in emerging markets (EM) currencies, has pushed corporate clients to hedge more, particularly since the lessons learnt in August 2015, during the Chinese renminbi's devaluation, where the impact was magnified by their lack of protection at the time. This interest is set to continue, as volatility and uncertainty are likely to persist.

The focus is shifting away from purely monetary policy tools to a combination of monetary and fiscal policy. This is a big change
Richard Cochinos, Citi

Richard Cochinos, Citi's European head of FX strategy, describes 2016 as the year of the tail risk, when probabilities were recalculated and approaches to risk management changed. From a macro point of view, questions about the effectiveness of central bank policy are emerging, again putting the onus on clients' risk management.

"The dominant paradigm since the financial crisis has been to listen to the central banks," Cochinos says. "The focus is shifting away from purely monetary policy tools to a combination of monetary and fiscal policy. This is a big change."

"I think, going into 2017, the market is quite rightly questioning whether this is the end of the bull market we've been seeing in rates since the 1980s. The market is starting to question valuations and EM suffers when developed market rates are moving higher. The rise of protectionism is also a concern, as a trade war between China and the US would hurt the global economy," says Giles Page, head of FX for Central and Eastern Europe, the Middle East and Africa at Citi.

In response to greater uncertainty and tail risks materialising, corporates and asset managers have started looking towards risk management on a portfolio level, and in a more holistic way.

"Corporates are more comfortable with using options and structured products now than they used to be, as the accounting treatment is well understood. Using forwards to hedge longer-dated exposures can incur capital charges and put pressure on their credit lines. Options provide a less capital- and credit-intensive alternative to hedging," says Sam Hewson, northern European head of corporate FX sales at Citi.

Innovation is also creeping into the corporate market. Flavio Figueiredo, Citi's global head of corporate FX sales, and head of the Europe, Middle East and Africa corporate solutions group, says some larger clients have started using banks to syndicate the credit risk for contracts that require a lot of credit, such as big, longer-dated forwards.

The industry's obsession with market share and volumes has shifted towards quality of service – a shift we wholeheartedly approve of
Flavio Figueiredo, Citi

"This is something we have seen happen in the interest rate swaps market before. The lead syndicate bank would execute the order in the market and then distribute the credit risk to the other relationship banks. A large, long-dated forward has two components: execution and credit costs. By doing things this way, the credit charge and market friction is reduced, and the overall cost is lower," says Figueiredo.

And, just like clients, banks have been forced to become more productive to minimise the transfer of cost increases from the sell side. "Our focus has been very much on becoming as efficient as we possibly can, to avoid price hikes for customers while providing the same level of service. We are, I think, managing to achieve this goal," says McCappin.

"The industry's obsession with market share and volumes has shifted towards quality of service – a shift we wholeheartedly approve of. The days of volume being the measure of success are over, and we are going to find that clients value quality and consistency more in the future than size," he adds.

Click for editor's introduction, list of interviews and awards tables