With its announcement Monday that it would stop promoting its online foreign exchange marketplace and instead become the 14th partner in a consortium called FXAlliance, Bank of New York shows how the Internet is derailing some banks plans to go it alone in this business.
The bank originally had decided to build on its thriving foreign exchange business by setting up a proprietary technology platform and inviting others to join it as equity partners offering their own services. But it found its effort dwarfed by new players like FXAlliance, one of numerous marketplaces to have sprung up in recent months, and this prompted its pullback.
Customers that signed up for Bank of New Yorks service can keep using it but will have the choice of moving to FXAlliance.
Foreign exchange is widely regarded as the biggest and perhaps most inefficient market in the banking industry, but it has been getting a makeover as various consortiums some sponsored by banks, some not compete for bank partners and the corporate relationships and liquidity they bring.
Not even Bank of New York, the latest to make a move, has a firm view of which way the market will go. Were not ruling out joining another consortium, said Richard C. Estes, a Bank of New York vice president. At this point there is not one single, multibank platform out there.
Indeed, banks have many options, all of them seeking to use the Internet to capitalize on a market that is as enormous as it is antiquated. Every day banks process $1.5 trillion of foreign exchange transactions more than the combined monthly volume of the New York Stock Exchange, the London Stock Exchange, and Nasdaq. Agreements on prices often are reached by telephone, fax, and stacks of scribbled notes.
The Internet offers a mechanism to achieve far greater efficiency. Within two years the share of foreign exchange trades done online is expected to triple, to 75%, according to the technology consulting firm TowerGroup Inc.
Christiane Mandell, head of e-commerce for global corporate investment banking at Bank of America Corp., said the shift to the Internet will change the dynamics of the market by creating transparency, so it will not be necessary for quite so many banks to be market-making. Ultimately, there will be fewer universal FX banks, she said.
Real change in the market began when online marketplaces sponsored by technology companies began gaining momentum. Lori P. Mirek, a former America Online executive with no banking experience, started Currenex Inc. of Palo Alto, Calif., which went live in May and now has 25 bank participants, including ABN Amro and Barclays Bank.
Ms. Mirek said she started her business because she considers the foreign exchange market so inefficient that a new technology company could easily grab market share. Foreign exchange is the Jurassic market, the most inefficient system in the banking market, she said.
A month after Currenex set up shop, so did another company, CFOWeb, which has similar ambitions and now says it has nine bank participants, including Bank of America and BNP Paribas. Then came Gain Capital, founded by a former foreign exchange trader who began targeting smaller portfolio managers and traders who make transactions valued at $10,000 to $1 million.
Yet another potential entry is the service planned by HotSpot F/X, also founded by a former foreign exchange trader. It expects to target corporations, hedge funds, financial institutions, and people who wish to trade anonymously.
These companies invite banks to offer their foreign exchange services through the sites and then take a cut of the spreads.
Banks responded to the incursions of Currenex and its brethren by building their own marketplaces. Last month 50 banks led by Citibank, Chase Manhattan, and Deutsche Bank announced the formation of a consortium called Atriax that offers research and quotes and is expected to introduce real-time trading in the second quarter.
Atriax is using technology from Reuters PLC, a major provider of foreign exchange services in the large transaction-driven dealer-to-dealer marketplace.
FXAlliance, which was announced in June, was the first bank consortium to surface. On Monday, in addition to announcing Bank of New York as its latest partner, it said that it had selected eight technology partners and secured a second round of investment from six of its members. It expects to be up and running next year.
Bank of New York said it will offer FXAlliance the trading system it developed for its own marketplace. In July it formed MarketMarque Inc., which teamed up with AVT Technologies to offer an expanded version of the iFX Manager system developed for its global custody clients. Other banks were expected to participate in the system as partners and equity holders.
Mr. Estes said the banks decision to throw in its lot with FXAlliance evolved over the course of this year as the number of competing consortiums rose.
We formed our company on the strength of our existing platform and figured we would add providers, he said. FXAll was searching for a platform but had the providers.
He said that Bank of New York and FXAlliance had been in discussions for some time about teaming up but would not comment on whether the bank considered joining Atriax.
In March, State Street Bank introduced FXConnect, a multibank Internet system that now supports trades initiated through seven other banks, including Deutsche Bank, and 250 institutional investors. The venture is still going it alone rather than as part of a consortium.
Like Bank of New York, State Street developed the marketplace for its global custody clients. Thirty-five percent of the banks customers use FXConnect.
Mark Snyder, senior vice president in charge of foreign exchange at State Street, said the bank would participate in other trading systems if its customers requested it, he said.
Though online marketplaces sponsored by technology companies have some momentum right now, banks seem confident that the large volumes they already process will ensure their viability in this business for a long time. But something must give.
It is clear that there are tech companies that can be intermediaries and do so successfully, Bank of Americas Ms. Mandell said. If they are prepared to set up infrastructures before financial services work with one another to set them up, she said, the tech companies will have life. But I am not sure who will have the longer life.
Industry experts predicted that the marketplaces, whether run by banks or nonbank companies, will enhance efficiency in an arena that desperately needs it. This would probably shrink spreads and eventually reduce the number of foreign exchange banks, they said.
Mr. Snyder said that when customers are faced with a choice on the same Web site, they will pick the winners in foreign exchange. In addition, real-time competition and listings of competitors on multiple sites will also narrow spreads, he said.
Ultimately, less efficient producers would be left out in the cold.
On the positive side, a more efficient trading market is expected to spur higher volumes and help make up for the lower spreads. Larry Tabb, a senior analyst at TowerGroup, said that in the end, foreign exchange profits will not be affected.
The Internet will also open the door for smaller asset classes to trade foreign currency, he said. Other asset classes will become very important as cross-border trading will globalize and U.S. investors will need to invest globally to save for retirement.
The third-party exchanges are a step ahead of the bank consortiums, which do not yet have fully operational systems. But observers see plenty of room for both.
Robert Iati, a senior research analyst at TowerGroup, said third-party systems represent a threat to bank-run consortiums, because they are already out there and the consortiums dont have a product. But in the long run, third-party systems will focus on a different client base that doesnt have the level of volume of the consortiums, he said.
The foreign exchange market is expected to become increasingly segmented, with different providers serving different types of customers. Third-party companies will serve corporate and institutional customers, while large bank consortiums will serve inter-bank and inter-dealer markets, and banks sponsoring their own systems will serve custodian customers, Mr. Iati said.
Many banks are expected to place their foreign exchange products and services on systems sponsored by banks and nonbanks, to ensure themselves a spot on a winning marketplace.
Though the technology-sponsored systems have an early lead, they may not prove to be the winning models. Mr. Tabb said the biggest players will be the ones sponsored by the banks, because they have the most liquidity and the ability to migrate their client base into an online environment.
Indeed, the largest amounts of money are expected to move the through the big consortiums, such as FXAlliance and Atriax.
Because Citibank, Deutsche Bank, and Chase represent the three largest banks in the FX market, they could be very aggressive on pricing, giving them an advantage over the competition, Mr. Iati said.
Ultimately, Internet foreign exchange is expected to support only a few trading systems.
It will be functionality and liquidity that drive which platforms survive, Mr. Snyder said. There could be two and at the most maybe three platforms, and in the end it will be end users who say which platforms have the functionality.
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