US banks fight back in FX forwards

The changing status quo among banks trading in foreign exchange swaps and forwards was one of the more dominant themes in the market over the past year.

Stricter implementation of the standardised approach to counterparty credit risk (SA-CCR) in the US compared with other jurisdictions meant the country’s banks were forced to charge wider spreads than their European and Canadian counterparts to cover the increased risk-weighted assets generated by the positions.

At one point in March last year, the difference in spreads quoted for G10 FX swaps between US and European banks was nearly 20 basis points, according to data collected by third-party transaction cost analysis provider BestX.

In such a highly competitive business, this led to a fall in market share for some US banks, including Citi and JP Morgan, that were previously leading the pack.

But they appear to have found a way to deal with the increased capital costs. Buy-side participants have noted that while spreads from European banks have remained the same, US banks have tightened their swaps pricing this year. Evidence from BestX supports this, showing that the spread differential has shrunk to 5bp.

This has had a positive effect on the banks’ market share, with the likes of Bank of America, Goldman Sachs, Morgan Stanley and Wells Fargo increasing the size of their FX forwards book during the first quarter of 2023, according to Counterparty Radar data.

How have the US banks been able to normalise their prices?

One way is by incentivising asset managers to collateralise their trades. While SA-CCR penalises non-cleared trades, collateralising them helps to offset this. And while there is no regulatory requirement for buy-side firms to post collateral on FX swaps and forwards, banks have offered more competitive pricing to asset managers that sign credit support annexes.

Banks in the US have also become better at managing the costs of trading. Some buy-side firms have noted that dealers’ appetite for certain types of business has changed and they are adapting their spreads based on capacity. Previously, this wasn’t possible as data on risk-weight costs at banks wasn’t as up to date and granular as it is now. As a result, internal bank trading desks are awarded increased budgets to offer more competitive FX swaps pricing.

In addition, the banks are making greater use of optimisation vendors such as Osttra and Capitolis. The latter recently completed an optimisation run with a record number of 20 firms, in which it reduced $341 billion in notionals used for the SA-CCR calculation.

Some suspect US banks have found other ways to pass on the costs of capital, potentially in areas of the trade lifecycle that are not picked up in buy-side transaction cost analysis reports.

As we have stated before, not all US banks are affected equally, meaning each firm is dealing with SA-CCR in its own way. But the moment in which EU and Canadian banks thought they could overtake their larger US rivals may prove to be short-lived.