The global foreign exchange (FX) market has a 'credit gap' of about $1.3 trillion according to research, which could leave many stakeholders in dire straits but no one is addressing the problem.

The $1.3 trillion 'credit gap' means there are 25 per cent fewer trading lines and this is leading to wider spreads, higher prices and increased foreign currency exposure for many participants. Increasingly tight regulations such as requirements for banks to maintain higher capital ratios, reduced risk appetite and fewer prime brokers are the main causes of this gap, according to research published yesterday by ADS Securities.

The number of FX prime brokerages has halved in the past two years, with six dropping out of the market, leaving just six major players. According to ADS Securities, the remaining FX prime brokers are also becoming more risk averse and profitability driven and will typically only take on those clients with the strongest balance sheets.

Global FX volumes could shrink

The size of the global FX market is estimated once every three years by the Bank of International Settlements (BIS), which last put the figure at $5.3 trillion in 2013. Estimates were for the market to reach $6.5 trillion by September this year, but experts are now saying this looks unlikely and there could even be no increase or a reduction on the 2013 figure.

Head in the sand

ADS Securities' Marco Baggioli called this shortfall “extremely significant”, saying: “The lack of credit will lead to much wider spreads and increased pricing for all, from banks, to hedge funds, international businesses and all FX traders and, at the moment, no one is facing up to the problem.”

The financial services company, based in Abu Dhabi, calls for certain FX brokerages to step in to support the institutional FX market by addressing the market gap in credit intermediation facilities.

Dramatic scale-back of prime broker services

The firm explains the current situation as follows: “This credit gap has been several years in the making. Following the global financial crisis of 2008 and the subsequent Swiss National Bank event in January 2015, a number of tier 1 banks have taken a more conservative approach to risk. Around the same time, the tightening of regulations – including demands for higher capital requirements – saw these same banks moving away from capital intensive activities. Ultimately, many banks have either stopped, or dramatically scaled back, their FX-only prime brokerage services.”

Situation is dire

Baggioli adds: “Two years ago a broker with US$5million capital might have been able to access a prime broker, but the capital they must now have has gone up to as high as US$50-75 million – so many cannot get the credit lines they need. Some smaller firms may be able to trade bilaterally with each liquidity provider and post margin accordingly, but this approach has a lot of limitations, including netting of risk and margin requirements. The situation is as dire for start-up Hedge Funds or those whose assets under management do not make the cut with the FX PBs.”