Global banks face stricter rules in Libor's wake
Regulators target the foreign exchange market to ensure the process of determining currency rates is not compromised.
As they try to resolve the stinging issue that has shaken customer and investor trust in the banking sector, the watchdogs are also training their guns on the largely unregulated foreign exchange market to ensure that the process of determining currency rates is not compromised.
The global forex market sees close to $4.7 trillion changing hands each day, and (as in the case of the LIBOR) it is the biggest banks that help establish benchmark exchange rates – something that clearly represents a conflict of interest, given these banks' strong presence in the forex trading business. The U.K.'s Financial Conduct Authority (FCA) is already looking into allegations that the two largest forex players, Deutsche Bank (DB) and Citigroup (C), are involved in manipulating exchange rates.
On the long term front, the International Organization of Securities Commissions (Iosco) is expected to propose guidelines to improve transparency and oversight on the sector soon, in an attempt to bring the forex market under the regulatory ambit. These developments will no doubt negatively impact the foreign exchange market in the times to come.
The global foreign exchange market is dominated by four banks – Deutsche Bank, Citigroup, Barclays (BCS) and UBS (UBS) – which together contribute to more than half the industry's size (see Deutsche Bank Tops Currency Trading List For Ninth Year In A Row). Deutsche Bank in particular is heavily invested in the business, which forms a substantial portion of its total sales and trading revenues. The importance of the sales and trading business (and hence the forex trading unit) becomes evident at once from the chart above, which shows that the business contributes towards half of the largest German bank's total value.
With all the banks already jousting with tighter regulatory requirements that threaten to shave off a chunk of their bond-trading revenues (see Deutsche Bank: The Bond Industry's Reform Will Lead To Further Consolidation), the idea that regulators are looking to tighten their grip on the foreign exchange market too does not go down quite well for the banks. While investors will ultimately benefit from the improved transparency and oversight on the largely unregulated industry, banks will be forced to settle for less from the lucrative business.
Deutsche Bank reports its foreign exchange revenues as a part of its fixed income, currencies and commodities (FICC) trading unit, and any impact on its total value from a reduction in these revenues can be understood by making changes to the bank's FICC trading yields chart shown below.
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