Online foreign exchange - At last, FX online

DATE 19-Aug-00
Online foreign exchange
The Economist, August 19, 2000

IN LONDON’S banks, foreign-exchange dealers used to be near the bottom of the sociological heap. And despite a recent influx of dealers with—heavens!—university degrees, many still recall street-traders. With turnover estimated at $1.5 trillion a day, foreign exchange is the biggest market in the world, and one of the most competitive, at least in the interbank market, where spreads are wafer-thin. The past six months have seen a flurry of initiatives aimed at using the Internet to bring this pricing to institutional investors and non-bank firms.
This week, it emerged that the three biggest participants in the foreign-exchange ( FX ) market—Deutsche Bank, Chase Manhattan and Citigroup—are teaming up with Reuters, an information company, to offer a range of FX services over the Internet. This initiative, tentatively called Atriax, is one of several intended to help users secure a better deal by allowing them to compare rates offered by a range of banks.

Reuters and Electronic Broking Systems ( EBS ), owned by a consortium of banks, already run two rival interbank electronic FX trading systems. Arguably, these were among the first electronic business-to-business exchanges—one reason why the FX market has been slow, compared with equity and bond markets, to develop Internet-based trading. The interbank market has enjoyed electronic trading for years.

Oddly, few non-bank corporations use either system. Instead, when they want to trade, they telephone one or more banks for a quote. This is time-consuming and, though banks deny it, gives banks a chance to make profits on the back of their clients’ deal-flow.

Recently, banks have set up proprietary electronic systems, giving clients access to their research and prices. Citibank and Chase Manhattan both offer such systems, promising clients greater efficiency—saving them having to phone for prices—and an array of analytical tools. However, both admit that clients would prefer a multi-bank site, rather that having to log into a dozen different websites to get a price. Understandably, banks are in no particular hurry to offer this, as the ability to compare prices can only put more pressure on their margins. State Street ran its FX Connect system for more than three years before opening it to other banks this year in response to pressure from clients.

Thirteen second-tier FX banks that account for around 31% of trading, compared with around 28% for the Atriax trio, have set up their own alliance, FX all. Banks, naturally, would prefer to lock clients into their own systems. But they have been forced to band together for fear that outsiders would get there first and start poaching business.

Currenex, the only multi-bank website currently operational, is a case in point. It is run not by a banker but by Lori Mirek, the former head of business-to-business initiatives at America Online, the biggest Internet service provider. Like so many Internet start-ups, Currenex is based in California, a continent away from America’s financial centre. It uses a panel of 25 banks—including Barclays, NatWest and ABN Amro—who bid against each other when clients post requests to buy or sell certain currencies. Ms Mirek says that Currenex’s lack of bank shareholders, and hence of conflicts of interest, is one of its key strengths. Like many online-finance sites, Currenex “wants to be Switzerland”, a country that is independent and neutral.

Alfonso Prat-Gay, a currency strategist at J.P. Morgan, an investment bank that was one of FX all’s seven founder-members, believes that, since banks are now co-operating, “relative minnows” such as Currenex will find it hard to survive. Other bankers claim that the importance of seeing competing quotes in the FX market has been overstated. Drew Gross, head of online foreign-exchange and derivatives trading at Chase Manhattan, argues that, typically, the spread between bid and offer prices in the market is only five-hundredths of a percentage point. This can easily be dwarfed by a day’s trading range—so it is better for a client to trust one bank that understands the market to deal on its behalf at the most opportune moment.

Retail of woe

Even if the Internet does bring cheaper foreign-exchange dealing to corporations, the retail customer, used to paying fees of as much as 5% to buy foreign currencies, will continue to lose out. There are relatively few Internet initiatives to cut the cost of foreign-exchange deals in cash or by credit card. But online shopping will surely create further demand for cheaper currency transactions.

Internet stockbrokers such as Charles Schwab and E*Trade are exploring ways of offering foreign-exchange services for cross-border share deals. To that end, Schwab has linked up with Barclays, a British bank. Other sites cater to sophisticated private investors. One, Matchbook FX , which was launched in New York last November, uses an order book to match client orders. But even here, the minimum deal size is $10,000—more than most people’s holiday spending requirements.

Richard Olsen, of Olsen & Associates, an economic-research firm based in Zurich, has bigger ambitions. Next month, OANDA .com, in which Olsen has a controlling stake, plans to launch FX change, an electronic communications network. He says that, amazingly, it will offer retail investors trading spreads even thinner than in the professional market. Mr Olsen sees the online FX market evolving as the equity markets have. Currency day-traders, he thinks, will become as common as equity day-traders are now.

The banks, of course, will do their best to ensure that such a “democratic” foreign-exchange market remains a pipe-dream. As in the corporate market, they may find themselves forced by online competition to shave their margins a bit. But, as their retail customers know, they have plenty of room for that.