UBS: banks that avoid passing cost rises on to clients will win

Rising costs and complexity have been a feature of life for sell-side market participants ever since the post-crisis regulatory reforms began, but as the implementation phase gets going in earnest, these expenses are starting to filter through to clients.

The question is: how much of the increases will be passed on to the buy side, and what impact will a full cost transfer have on volumes and liquidity in the extremely low-margin business of foreign exchange?

"Our aim is to help clients experience the same level of service as they are used to from UBS, even though the complexity of daily business and cost of doing business is rising. Regulation is adding extra costs to business, but we are working hard to make sure the burden of these costs land on us and not our clients," says John Newman, global head of FX options at UBS.

The race will be won by the banks that are most successful at avoiding passing on costs and are able to keep the client experience the same
John Newman, UBS

"I would like clients to say in two years' time that there wasn't a change in [the] complexity of doing business with the bank. The race will be won by the banks that are most successful at avoiding passing on costs and are able to keep the client experience the same. Firms that do that will emerge as winners," he adds.

To achieve this, UBS is investing in improving its risk aggregation systems and infrastructure to commoditise as many products as possible, while making them transparent and efficient. This is especially important for the more complex derivatives, where clients have historically had less transparency regarding the value of a product during the contract's life cycle.

More automation allows traders to concentrate more of their time on risk management, which has become critically important as market conditions and the liquidity landscape developed. Meanwhile, the 2015 Swiss National Bank event and the devaluation of the Chinese renminbi have changed perspectives sharply.

Model lessons

"The lessons learnt in 2015 have shown us that VAR (vector autoregressive) models are not as accurate at predicting maximum losses as some people had thought, and this forced market-makers to re-evaluate their approach to risk and the way they look at gap risk," Newman says.

"Absolute volatility was higher in 2015, but in 2016 the vol-of-vol is much higher and the gapping moves we have seen around key events demonstrates how much liquidity has changed. The aftermath of Brexit was challenging and we have seen a complete deja vu with the US elections," he adds.

Since January 2015, no one knows more about gapping moves than Swiss franc traders. The epic 20% move in EUR/CHF was the equivalent of watching the impossible playing out very fast. And while the SNB removed its official currency floor of 1.20 in EUR/CHF, traders in the currency are more than aware of the central bank's tolerance levels for the franc's strength.

The unofficial line in the sand is considered to be around the 1.08 level. Sight deposit numbers from the SNB show the central bank has been active in currency markets and the franc throughout 2016, preventing it from appreciating. These upticks in sight deposit numbers usually come after EUR/CHF approaches 1.08.

London and Zurich will now work as a joint centre, demonstrating our commitment to serving our clients in the best possible way
Sandro De Toffol, UBS

"The franc remains to be seen as a safe-haven currency. The whole point of not having the official floor is that it gives the SNB more flexibility, and it's possible that over time the central bank's tolerance will move," says Sandro De Toffol, a Zurich-based FX trader at the bank.

Competition from non-bank market-makers has also increased; a positive development for the overall market, according to De Toffol. And with volatility and occasional stress events set to feature next year, UBS has established a new trading desk in London to be closer to clients.

"London and Zurich will now work as a joint centre, demonstrating our commitment to serving our clients in the best possible way," De Toffol says.

"We see increased competition in market-making as a positive for the market and we are comfortable that we have a very strong product offering. We have proven to be reliable, with a strong commitment to providing liquidity and prices at all times," he adds.

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