FX Markets Best Banks Awards 2020: Best bank for FXPB, post-trade services and SMEs – NatWest Markets

Despite unprecedented disruptions brought about by the Covid‑19 pandemic, new clients continued to use NatWest Markets’ FX prime brokerage business in 2020 due to its uniquely diversified approach

In a year dominated by an unprecedented market frenzy and uncertainty, market participants in 2020 relied heavily on the resilience of liquidity providers to help navigate the vagaries of the market and support adaptation to the changing world.

For financial firms, the volatility provided an opportunity to take advantage of rapidly changing market movements while for smaller corporates it meant recalibrating FX exposure in light of evolving client supply and demand chain disruptions.

While 2020 was a bumper year for NatWest Markets’ FX prime brokerage (FXPB) business, it wasn’t without its challenges. Records for the number of tickets processed in a single day on many electronic communication networks (ECNs) were repeatedly broken, which made sourcing liquidity on these platforms somewhat problematic at times as the upper bounds of trading limits were easily reached on the most volatile trading days.

Trading volumes were perhaps higher than usual on some days, but market participants’ overall risk position may not have been, explains Marcus Butt, global head of prime services at NatWest Markets. This hindered trading now and again as the bank had to constantly amend these limits with ECNs. To preclude such occurrences in the future, the bank is currently working with the global financial markets association on better managing these limits in prime brokerage.

Despite pandemic-induced market disruptions, new clients continued to make their way to NatWest Markets’ FXPB business in 2020 as the tremors that shook the prime brokerage space two years ago persisted. 

“We had a cracking year in prime brokerage last year,” says Butt. “We onboarded lots of new clients and continue to onboard new clients as a lot of people are still nervous because of the repositioning that happened at one of our competitors. There is now a general push towards more diversified providers. Where historically market participants were using one prime brokerage they now have at least two because they want a backup in case there are further changes in the market. Not being reliant on a single provider is a sensible approach that makes a great deal of commercial sense.”

At the same time, other market participants were approaching NatWest Markets because they were faced with the daunting prospect of being caught by the uncleared margin rules (UMR) as the gradual lowering of the thresholds meant a large swathe of market participants were about to be brought into scope in 2021 or 2022.

For many of these firms, FX is such a small part of their business that finding a cost-effective solution to manage collateral lines with a large number of banks to fulfil best execution requirements poses a dilemma. Managing collateral with many liquidity providers is a costly endeavour logistically and legally, points out Butt, and even more so for those with comparatively little FX volumes. They were therefore coming to NatWest Markets for solutions.

On the surface, prime brokerage would seem an appropriate solution for those firms, but with modest FX volumes that didn’t make it worthwhile either.

“Prime brokerage may seem like the answer to these clients, but actually prime brokerage itself comes with its degree of overhead,” explains Butt, “so what we’ve done is develop a new offering for our clients, which is a combination of prime brokerage infrastructure and network with our segregated order execution desk. It allows clients who aren’t prime brokerage clients to access the prime brokerage liquidity network through our segregated desk.”

“This is a good solution as it’s a hybrid of the best of what we’ve done for prime brokerage and making it available to a much wider audience. Traditional prime brokerage is an overly heavy solution for these clients.”

Through this client agency prime execution solution, clients can leverage their existing relationship with NatWest Markets and outsource the execution of their trades to the bank and profit from the netting benefits as well as the legal, collateral and operational efficiencies that this entails. Consequently, market participants do not go to market directly, but instruct the bank as to how they want their trades to be processed. They can ask NatWest Markets to find them a certain number of prices for each quote or opt to consume NatWest’s price.

“It’s very flexible in how the end client chooses to let us execute trades on their behalf,” explains Butt. “We’re still intermediating those trades, so from that point of view it looks like a prime brokerage arrangement. NatWest Markets faces whoever the liquidity provider is, and NatWest Markets faces the underlying client. It looks like prime brokerage trade, but the execution method makes it far more accessible to a broader group of clients.”

This is especially the case for managers that conduct trades on behalf of separate legal entities. Under UMR, sub-accounts would have to be created for every single one of those entities with each liquidity provider with whom collateral is being exchanged, which could quickly lead to large numbers of accounts to create and manage, and at great cost.

“To set all of that up and put the lines in place for each individual entity would be a huge overhead,” says Butt. “And individually none of those entities may be sufficiently active to make that worthwhile.”

Since its launch in 2020 the service has attracted a wide range of clients. On one side there are those, like asset managers, looking for access to prices from an agency desk without the legal overhead of setting up bilateral relationships, while for others benefiting from collateral efficiency without the cost of setting up countless collateral accounts may be more of a priority. 

While the client agency prime execution solution is gaining popularity, it’s unlikely the new service will cause an exodus of clients out of prime brokerage as market participants that are more likely to opt for the segregated desk option are somewhat different to prime brokerage clients.

“I think it’s really a different audience,” says Butt. “Prime brokerage has historically been for clients that have quite high volumes. There is quite a lot of legal documentation that’s required to put prime brokerage lines in place, to monitor them and manage that whole process. There is a threshold at which it would not be economically viable to set all of that up.”

SMEs readjust FX consumption to new reality

For non-financial market firms, 2020 was rather different than for other market participants. As their operations were thrown off kilter by the pandemic their carefully crafted forecasts of FX consumption for the quarters to come were thrown into doubt.

For small and medium-sized enterprises (SMEs), which tend to forecast their FX needs based on models fine-tuned over many years with a reasonable degree of confidence around their accuracy, the onset of the pandemic completely changed that dynamic as some operations were shut due to government-imposed lockdowns. In some instances, SMEs’ currency needs changed overnight as supply chains were irrevocably disrupted and consumer demand transformed.

Many SMEs were left with FX forward contracts and long-term hedges on their books that were no longer appropriate for their new currency needs, says Stuart Wilson, head of UK mid-corporate FX sales at NatWest Markets.

The bank, which was voted best bank for SMEs, FX prime brokerage and post-trade services at the 2020 FX Markets Best Banks awards, caters to larger corporates on a worldwide basis, but its SME customers are typically businesses with UK- and Ireland-based operations.

NatWest Markets spent a large part of 2020 working with clients to understand how their currency needs changed and how they could amend their forecasts and reset hedging programmes already in place. And as the person responsible for FX in an SME often wears many hats within the company the bank’s support in this endeavour was crucial.      

“Our purpose is to help our customers succeed in doing business internationally and so we made great efforts throughout the pandemic to stay close to our customers to understand their changing currency requirements,” says Wilson. “The big challenge for them was to reprofile their maturing hedges during the pandemic to reflect the underlying reality of their currency needs, and how these differed from what they had been forecasting and hedging prior to the pandemic.”

During much of 2020, uncertainty was often too great for SMEs to plan their currency exposure far in advance. Some firms began to move away from forward contracts in favour of the spot market for their currency needs while others sought greater optionality in their FX forecasting and hedging.

“Forward contracts are simple, but they’re also relatively rigid and inflexible,” says Wilson. “Businesses now have less confidence in the accuracy of their forecast of future currency exposures because there are too many external events that could change. Let’s be clear, forward contracts remain the most prevalent hedging tool for SMEs, but there is an increasing willingness to explore alternatives given the experiences of the last 12 months.”     

“More businesses are now looking at how they can incorporate a degree of optionality to their currency hedging. This can have the twin benefits of allowing them to take advantage of markets that move in their favour, as well as reducing the chance they might find themselves overcommitted or over-obligated in the event their currency exposure needs change significantly.”

For SMEs that do go ahead and hedge their currency exposure, they are more likely to hedge a smaller portion of that now than previously. 

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