Foreign exchange is the world's largest financial market.While technology has been slow to take advantage of the opportunities it offers, are we slowly seeing signs of change?
The ability for digital technology to disrupt and then revolutionise entire markets is enormous. We"ve already seen the music, publishing and travel industries changed beyond all recognition. Today, public transport and the hospitality sectors are under assault from the likes of Uber and Airbnb. In the financial arena, we are all used to online banking and are moving slowly towards a world of cashless payments.
These changes have made life much easier for consumers. Yet despite such technological advances, the financial services industry itself hasn"t changed a great deal. The big-name banks and institutions are the same ones that dominated decades ago.
And while they have successfully adopted technologies that help deliver better services to their customers, they are yet to come under serious threat from competitive and disruptive new technologies and businesses. Yes, Bitcoin raised some eyebrows and peer-to-peer lending is growing, but they still remain "areas of interest" to the big institutions rather than a genuine threat.
The foreign exchange (FX) market is an excellent example of the slow pace of change in the financial services industry. Until recently, individuals
and companies were pretty much at the mercy of market movements, with banks and FX firms setting seemingly arbitrary buy and sell prices for currency and then slapping healthy charges on top.
This does seem to be changing gradually - perhaps most notably in the money transfer sector, which we will come to later. But the pace of change is hardly cheetah-like, and this is what is puzzling about the FX sector, especially when we examine the institutional arena.
By volume, FX is the largest market in the world, which, according to the Bank of International Settlements" Triennial Market Survey, was trading at an average of $5.3trn per day in April 2013.
It"s easy to think that an unregulated market of such staggering proportions would attract disruptors in their droves.
If more than $5trn a day is being swapped from one currency to another, then surely the prospects for doing business in an entirely new way and capturing some of those very healthy commissions would prove irresistible to
a money-motivated tech-head?
Not so, says Trevor Charsley, Senior Market Advisory Consultant at global currency exchange firm AFEX, which is about to open an office in Jersey. “Technology is fantastic, but what is often overlooked is expertise,” he says. “Having access to someone who can be on the end of the phone and is able to explain the situation is important.”
Minimising risk
The personal touch is important in the FX market because, aside from spot transactions, the type of services that institutions are looking for can be complex. “The space I work in - offshore and asset management - has seen growth in the need to hedge,” says Charsley. “Five years ago there was very little hedging, but now the need is greater and the market has grown.”
Hedging is all about taking the risk out of FX transactions. “It creates a stable platform so that clients can concentrate on building their business with certainty,” explains Charsley.
That doesn"t mean all offshore companies are looking to hedge. The market for spot transactions is important to the Channel Islands" finance sector as it looks after both its business and its private clients.
The key difference between hedging and a spot transaction is that the latter is entirely at the whim of market rates - today"s transaction can quite easily be a better (or worse) deal than tomorrow"s, but there"s no way of knowing for sure. The only place for clients to look to improve the deal is to reduce the margin taken by their partner on the other side of the exchange. It"s in this area that companies in the islands are wising up to the potential for cost reduction.
“The industry has become more aware of the margins that banks are taking,” says Kevin Moore, Head of Treasury Services at Jersey-based Enhance Group. Driven by the aim of providing an FX function that essentially provides a better service to clients by undercutting the traditional bank driven model, Enhance has developed a foreign exchange platform in partnership with fintech provider Ebury.
“We sat down and looked at what the sector would need and devised a platform that we thought would suit the industry,” says Moore. “We concentrated on full transparency. There"s no middle man, there"s no hard mark-up.”
Despite claiming savings of up to 75 per cent on transactions for some clients, Enhance doesn"t see the system"s success as being purely a result of price benefits. Having listened to potential users during development, it was clear the market needed a less complex, more transparent method for exchanging currencies.
“It"s a fast and highly complex market, but it shouldn"t be,” says Moore. “We wanted to allow the client to see the process and put a fair price on it.”
Sending money home
Institutions will always dominate the $5 trillion-a-day forex market, but there"s no doubt that the market is worth a great deal at the individual level. Moore has seen a “massive increase in the volume of tickets that go through in the £0-£100,000 value range”, as his main clients - trust companies - pass on the benefits of the Enhance platform to their private clients.
We may look out for the best deal when buying currency for our annual holidays, but our tendency is still to turn to the banks or the post office for these one-off exchanges - any price difference is minimal, so it"s not worth looking any further for the very best prices.
This isn"t the case for individuals who are part of the $600bn per year remittance market. Research by the World Bank estimates that the growth in the movement of migrants around the world has led to this market growing at a rate of 3.75 per cent annually, with a huge bias of money sent from the West to the East. The US sends 22 per cent of that $600bn, while India receives 12 per cent.
Until recently, the only players in town for migrants looking to send home money were the wire transfer companies such as Western Union. However, that is changing as entrepreneurs look to use technology to provide competition in a sector that has changed very little over the decades.
London-based Lithuanian start-up TransferGo is doing exactly that. In two years it has gained 77,000 returning customers who are looking to cut the cost of sending money to friends and relatives.
“The main goal of TransferGo is to create frictionless payments for people and to make it cheaper and easier. We cut the cost of sending money abroad by up to
90 per cent,” says TransferGo"s Brand and Marketing Communications Manager, Guste Sadaunykaite.
Currently focused on serving migrants from Central and Eastern Europe, but looking to expand geographically, the company"s founders developed the service following their own dissatisfaction with the market when they were migrants.
“We work in 33 different countries and have developed partnerships with 60 banks to deliver our "local in, local out" model,” explains Sadaunykaite.
This model dispenses with the need for a transfer network. Instead, online users deposit local currency into TransferGo"s bank account in the country in which they work and the company pays it from its account in the destination country to the intended recipient.
Being online and using the existing networks provided by their banking partners has enabled TransferGo to cut the cost of international remittances. And that means migrant workers see less of their earnings being taken.
Claiming transaction growth of 20 per cent per month and having exchanged more than $100 million so far, TransferGo"s model appears to be working in the marketplace. Although it remains tiny within the size of the global market, the business could be the beginning of the end for the wire transfer companies" dominance of the growing remittance market.
The initial success of Enhance and TransferGo - and companies like them - suggests the FX market is changing, driven by the opacity of the traditional wire transfer and banking models. However, FX is a complex market and the changes we are seeing today are principally confined to spot transactions. When it comes to risk management in the form of hedging, there is every chance that the personal touch delivered by firms such as AFEX will be with us for a long time to come.