London Brokers Pessimistic About Year Ahead Credit Concerns, Bank Mergers, Reuters Cited

After a year that saw a wave of lay offs and declining volume and with war in the Gulf a near-certainty, London foreign exchange brokers looked nervously ahead at 1991 with understandable pessimism--exacerbated by the tense atmosphere on January 15 as trading slowed and people waited for news.

"I've never seen such uncertain times," says Gary Klesch, until recently chairman of broker R.P. Martin and still the proprietor of parent Martin Bierbaum. "There are so many things that could happen." Klesch worries about the effect of a lengthy war on the already-weakened U.S. and U.K. economies--and the likely further devastation of the banking industry, brokers' primary customers. "In times like these, banks become risk-averse--that's not good for any trading business," he adds.

Klesch and others expect continuing mergers among banks in the U.S. and Japan, which may lead to declining volume--and hence more carnage among already hard-hit brokers. "Brokers will certainly have to scale back to reflect new levels of activity," says Klesch. "We may lose one or two brokers--the number certainly won't be growing," agrees Samir Saffadi, a managing director at Tradition Financial Services. Suggests a director at another major brokerage, "People will be reallocating resources from one area to another--or perhaps reducing salaries."

The most optimistic are the foreign exchange options brokers, one area that grew in 1990 and that banks expect will continue to grow in 1991. Brokers say that as BIS capital regulations bite into banks' trading capabilities, off-balance-sheet instruments like options become more and more attractive.

"[Options] volume increased substantially in the fourth quarter of 1990. I don't see why 1991 should be any different," says Tradition's Saffadi. The uncertainty, he says, may even be a benefit. "The more uncertainty, the more interest there is in options."

The success of options is in part due to the cloudier picture in forwards, where volume contracted substantially in 1990. "Forwards are being superseded by currency options," says one director at a major brokerage house who preferred to remain unnamed. "There's a kind of us and them attitude in the forwards market about options," agrees Peter Hayward, who heads the options desk at Exco International.

Nonetheless, Hayward thinks that the gloom is a bit of an overreaction. "After all, you can't price the options without the forward price." Others say that forward trading activity is likely to improve as netting schemes come on line, reducing concerns about credit and the capital needed to support a given forward position. That would help brokers, who don't tend to run large positions themselves, but who often find deals scuttled by unexpected credit limit problems.

Another cloud on the horizon is the advent of Reuters' Dealing 2000-2, its electronic order-matching system that some think may cut out some brokerage business. Brokers--while skeptical that Reuters will ever finish the often-delayed system--are a bit worried. "There's no question that Dealing will take a share of the market," says Klesch. Agrees another brokerage house director, "Brokers always worry when a new competitor enters the market."

But some suggest that the Dealing system may also bring in new customers and add to liquidity. And others point out that the necessity for users to put all their cards on the table by entering size and price parameters may deter some banks--camouflage, after all, is one of the reasons banks use brokers in the first place.

In fact, as one broker pointed out, the expectation that fewer players will be in the markets in 1991, even though it may mean that liquidity will suffer, may not be completely bad news. "When you have fewer, more mature players, each will trade in larger sizes and take on bigger positions," says Tradition's Saffadi. "And as they trade more size they need us more."