Citi scrape could change FXPB skyline

About six months ago, a senior banker was venting about the lack of client clearing in foreign exchange markets.

He put the blame squarely on LCH. Clients were paying a fee of $5 per million notional to trade non-deliverable forwards (NDFs) with their prime brokers. LCH’s pricing was 20% higher than that when it started offering the service – and after adding a clearing broker’s fees, a client would end up paying far more to clear than not to clear.

No wonder clearing houses were struggling to attract business.

Now, another bank sees the status quo being turned on its head. An April white paper from Citi claims FXPBs have been grossly underpricing NDF transactions for years. Fees would have to rise 31-fold to fully compensate FXPBs for their costs, and clients would be better off sending their NDF trades to clearing houses, the authors write.

So what changed?

Citi’s call to hike fees comes after it suffered a reported $180 million loss in its FXPB business. One of its clients, Hong Kong-based GTEC Pandion Fund, took the hit on a series of long-dated variance swaps on the Turkish lira. It was charged only $30 million in margin to enter the trades.

The fallout was swift and severe. The FXPB business was moved out of the currency trading division and placed within the clearing unit. Sanjay Madgavkar, who ran FXPB from 2012, was ousted and replaced with Chris Perkins, global head of OTC clearing, and one of the co-authors of the recent white paper.

Those moves could have wide-ranging implications for FXPBs, and forex clearing. Foreign exchange divisions can subsidise their prime brokerage fees with execution revenues. Clearing units have no such side income, and no incentive to compromise on risk management or client selection. Citi has already told some smaller clients to find new homes.

Clients were paying a fee of $5 per million notional to trade non-deliverable forwards with their prime brokers. LCH’s pricing was 20% higher than that when it started offering the service

Those that stay could see their margin requirements rise, perhaps starkly. Several sources told Risk.net that Citi’s FXPB required less margin than many peers for complex, non-linear products like forex options and variance swaps. That is likely to change under the clearing unit’s watch, even before the bulk of FXPB clients become subject to the non-cleared margin rules in the next year or two.

Once those rules are in full effect, the white paper estimates the fee for an NDF climbing to $155 per million notional traded.

Who pays the bill is a matter for debate and, so far, it has not been particularly nuanced. The Citi executives argue executing dealers also benefit from prime brokerage and should share their clients’ growing costs; other FXPBs say that’s wishful thinking.

In the meantime, LCH has slashed client clearing fees for NDFs, which now stand at $2 per million for emerging market currencies. Even after paying clearing brokers, clearing now looks like a bargain.

Update, May 13, 2019: This article was updated to clarify LCH’s fees for clearing client NDF trades.