The rise of P2P FX
A New York-based fintech believes it has devised a platform that could finally unlock the substantial potential savings promised to corporates who exchange currencies with other companies rather than trading with banks.
Foreign exchange is the world’s most valuable financial market. The most recent BIS triennial central bank survey found that $6.6 trillion of currency was traded every day in April 2019. The major global banks sit between the buyer and seller on many of these transactions, generating billions of dollars a year in fees.
For decades corporate customers simply accepted these costs, in part because they didn’t know exactly what they were paying since bank fees were built into the exchange rate but also because they couldn’t take their business elsewhere. Then as the FX market opened up and peer-to-peer financial services emerged, the concept of ‘swapping’ currencies began to generate interest.
A number of peer-to-peer FX companies hit the market, but over the years many have fallen by the wayside while others have changed their business model. One of the reasons why corporates have been slow to take their FX business away from the banks is that it is often offered as a package alongside other financial services.
Indeed, Claude Goulet, CEO of institutional peer-to-peer netting platform Siege FX suggests this is the main reason why peer-to-peer currency matching has struggled to appeal to corporates. “This is particularly true for medium-sized and smaller corporate entities which have a greater dependency on their lending relationships and seek to bundle FX flow and hedging services with this balance sheet provision,” he explains.
However, buy side matching utility FX HedgePool’s founder and CEO Jay Moore believes there is a more straightforward reason why corporate peer-to-peer FX has struggled to gain traction – it has focused on the wrong part of the market.
He suggests that spot trades (where currency is traded for delivery on a specified or ‘spot’ date) are too unpredictable to be matched on a regular basis, whereas swaps (where one party borrows one currency from, and simultaneously lends another currency to, the other party) are more suited to the peer-to-peer model.
“We are focusing on the swaps market and more specifically, the requirements of passive FX hedging programmes,” he says. “Most of these programmes use forward contracts rolling on a monthly or quarterly basis in the form of FX swaps. These swaps are highly predictable, which means we can curate a community of peers with predictable flow that naturally offset one another.”
Institutions that use passive FX hedging programmes include pension funds, asset managers, insurance companies and hedge funds looking to hedge the currency risk in their global investment portfolios or offer hedged share classes denominated in foreign currencies.
FX Hedgepool’s model does not completely remove banks from the process since its customers rely on the credit and settlement functions provided by their banks. Indeed, Standard Chartered Bank has signed up as the platform’s initial credit provider.
The firm had to ensure that its integration requirements are non-disruptive to participating banks’ existing workflows. “Even a good product can fail if the onboarding demands are intrusive, lengthy and costly,” acknowledges Moore. “We have also seen that banks have been strategically evaluating the platforms they support for their clients and pushing back if the costs to support these platforms outweigh the value they receive.”
Workflow integration is also a vital consideration for Siege FX, whose CEO says larger institutions have become increasingly aware of their market impact costs and who is holding risk. “Our deterministic system needed to be easily embedded within current as well as new client workflows and rapidly deployed,” adds Goulet. A deterministic system can be defined as one that will always produce the same output from a given starting point.
Of course, companies don’t really care how their trades are conducted as long as they are getting the best outcome. Philippe Gelis, CEO of currency management solutions provider Kantox says that while some retail customers like the peer-to-peer concept, corporate clients are completely indifferent.
“This is why we stopped offering peer-to-peer services,” he explains. “What corporates really look for is transparency, immediate liquidity in any currency pair and technology to automate FX risk management and optimise execution. The largest banks hardly match more than 25% of their own order book, so matching a large proportion of trades is not realistic.”
CurrencyFair is an established peer-to-peer currency exchange marketplace. Yet its CEO, Paul Byrne, agrees that his customers are generally more focused on cost, speed and the quality of service as they make payments with short time spans.
“Historically CurrencyFair and other online payment companies were focused on peer-to-peer matching of FX flows for all clients,” he says. “However, as our business has grown that has all changed. We have the same access to the wholesale interbank market as any large bank, so our customers have real time execution of their FX transaction, combined with immediate payment and local clearing without the need for correspondent banks.”
However, Goulet is confident that peer-to-peer initiatives aimed at helping corporates transact more efficiently will continue to gain traction.
“As we have seen in the equities and securities markets, peer-to-peer or crossing networks have become important sources of alternative liquidity,” he concludes. “When compared with these assets, FX has a more homogeneous set of instruments and a greater diversity of participants, which provides a very interesting opportunity.”