Discriminatory Pricing Practices in Corporate FX
This article is a contribution from our content partner, Just The following is a transcription of our CEO, Anders Bakke’s, recent webinar: How to protect your business from overpaying on FX transactions. My name is Anders Nicolai Bakke, I’m a serial entrepreneur who’s been in the capital market for a long time and is now proud to be the CEO of Just Technologies. My team and I founded Just Financial during the acquisition of our first capital technology platform back in 2017. We wanted to start another business to solve treasury related problems for companies dealing in the FX market. In this webinar, we’re going to be covering the following: I hope you enjoy it and hope to be able to answer some of your questions at the end. Understanding the FX market I want to first talk about how over-the-counter financial markets are opaque and often hard to manoeuvre for non-financial institutions, such as private companies. What we’ve found at Just is that, in any market where you don’t have access to high-quality data, you are at a considerable disadvantage compared to those who do. In the FX space, counterparties are the ones who have access to the true market rates and they have found ways to monetise that disparity. This is a systemic problem within the market: companies are losing value during FX trades and that value is instead flowing into the profit pools of the banks. So how did this systemic problem manifest? Well, let’s take a look at the FX market and its discriminatory pricing practices: The FX market is very efficient as long as you’re on ‘the inside.’ Whether you’re on the inside is determined by how sophisticated you are, how many counterparties and data sets you have access to, and the understanding you have of the FX space. If you do have access to the right data and counterparties, then you can do your own price discovery and see if you’re getting a fair deal on your FX trades. If you don’t have access to this information and your FX provider knows this, then you’re probably being taken advantage of. Businesses (especially those who aren’t directly related to FX) usually only have access to the prices they see from around one to three banks. This is an issue because the fewer counterparties and rates you see, the less you have to compare. It doesn’t help that the rate banks show you is not the real market rate — it’s a rate that’s marked up both from the SPOT component and credit component. Because FX contracts are entered bilaterally (either peer-to-peer or principal-to-principal), banks themselves admit that it is easy for them to make a profit. Suggested reading: To understand more about whether your business’s FX rates and margins are fair, take a look at our article. How margins are structured in the FX market Now that we understand the issue at hand, we can look at how margins are structured in the FX market. Let’s say a large European bank wants to acquire $1 million from the interbank market. They would go to another large European bank and conduct the same kind of currency trade that everyone would imagine. The typical fees they’d pay for this acquisition would be somewhere between $2-10 per million. That $10 per million includes: So the bank pays that $10, and then turns around to find that one of their largest clients (say in the top 1% of flow) also wants to buy $1 million. In this case, the bank knows that this powerful company has the ability to ask 10-15 banks for a quote as they’re probably on an auction platform, or they have a Bloomberg terminal. Given the potential competition, the bank knows that it’s in their best interest to win the deal as quickly as possible, so they mark up the trade to just $50 per million. If the client accepts that fee, then during that entire process the bank has made a decent profit: they themselves paid $10 to acquire the currency from one of the other banks, and then went on to sell that amount for $50, therefore giving them $40 to pocket. But what about the other 99% of their clients who aren’t as large or savvy in the FX market? What about the average importer and exporter? What about companies who just need to trade $1 million in a vanilla trading pair rather than hundreds of millions? Unfortunately, these large banks know that the average company does not have access to enough counterparties to properly take part in FX auctions. They can therefore charge these companies whatever margin they wish. After many years of analysis, Just has determined that the average margin that banks give to businesses is between $200 – $20,000 per million. Compared to the average $10 that banks charge between themselves, we find this to be pretty insane! There is so much value-leakage from the corporate space that goes straight to the banks and it is for this key reason that we decided to launch our business. Why FX knowledge is important We’ve been in the market for a while now and what we’ve seen across our 100+ clients is how easy it is to approach banks for a real conversation on margins — as long as those businesses are armed with data. Why is this information important to you as a corporate treasurer or CFO? The solution This is not a piece about selling a product — it’s about exploring a systemic problem within the market. And the solution to this problem is actually quite simple. In order to protect yourself from overpaying, you need market data. In most cases just having access to non-tradable rates from Google or Yahoo Finance is not good enough. You need a systemic approach that allows you to see your historical exposure, volume, and current hedges so that you can build a case from which you can sit down with your bank. For this purpose,…
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