Too Many or Too Few? Corporates Seek to Diversify FX Banking Pool

A survey of UK-based CFOs published in October by MilltechFX found that 62% believed there was a lack of transparency in the FX market that could be attributed at least in part to a reliance on a small number of counterparties. An average corporate was working with just three counterparties and only 1% had five or more counterparties.

Almost three-quarters (73%) of the UK-based CFOs surveyed said they were looking to diversify their FX counterparties, a figure that rose to 88% in a similar survey of North American CFOs published in July.

Corporate Strategy for FX Counterparties

"It can take months, even years, to set up banking relationships and our research shows the majority of corporates only work with three banks,” says Eric Huttman, the CEO of MillTechFX. “It is therefore positive to see that most corporates are looking to diversify their FX counterparties. This is not only beneficial from a risk management perspective but has the added benefit of providing corporates with the ability to compare prices, aiding transparency and enabling best execution.”

Antoine Jacquemin, the Global Head of Market Risk Advisory & Head of Corporate Sales Europe Ex-France (FX and rates) at Societe Generale agrees that the move by corporates to diversify their pool of FX counterparties has been driven by companies looking to replace some banks that were in their FX panel group and disappeared during the first half of the year.

“The average corporate client would have somewhere between ten and 20 banks on their panel,” he explained. “I would be surprised if they were trying to double the amount of banks they are doing FX with, but they are adding numbers at the margin.”

Jacquemin reckons the number of banks that are not necessarily top FX counterparts to corporates but are looking to become more important is also contributing to this trend. This is especially true for those who lend to corporate clients because clients tend to share their ancillary business with the group of banks that are lending to them.

“Then we have to consider that corporates have FX requirements in emerging or even frontier markets,” he said. “The average treasurer or CFO will want adequate competition for every currency, which by definition would require a pretty large panel group because different banks have different capabilities.”

Concentration of Counterparty Risks

Corporates who limit their banking partnerships benefit from not having to manage and divide their finite FX wallet across numerous counterparties. In so doing, they have also become more comfortable asking for analysis, advice, and bespoke content.

However, working with a small number of banking partners leads to a greater concentration of counterparty risk observed Scott Sinawi, the Head of Corporate Sales for Global Markets Americas at BNP Paribas. “This can be managed by only trading with the highest credit quality banks and also managing positions – and resultant exposures – across banks,” he mentioned.

“Another downside to working with fewer banks would be the potential for gaps in pricing certain currency pairs and structures. This too can be offset by careful selection of banking partners who can provide liquid and competitive pricing in both G10 and emerging market foreign exchange products.”

When asked whether March's banking crisis in the US and the collapse of Credit Suisse encouraged corporates to review their FX banking relationships, Sinawi suggested comprehensive counterparty review pre-dates the events of 2023.

“The 2008 global financial crisis was the real impetus behind corporates giving greater scrutiny to counterparty risk,” he stated. “Credit Suisse – and to a lesser extent the US regional bank crisis – was just another reminder of the importance of maintaining a diverse, creditworthy group of FX bank counterparts.”

“We did not see the need from corporates to diversify and/or increase the number of FX banks they work with,” Sinawi added. “Most of the corporate clients we see do not work with US regionals for their FX hedging needs.”

A Conundrum

On one hand, working with a smaller group of FX banks means managing fewer relationships and having fewer 'mouths to feed.' However, this also leads to less competitive bidding for trades and fewer opportunities for research and other banking resources.

Julie Ros, the Strategic Advisor to the Foreign Exchange Professionals Association, pointed out that the association has noticed a trend towards prioritizing partnerships with global systemically important banks, rather than than expanding the number of banking relationships, particularly in the early part of this year.

Deciding on the number of counterparties is a collaborative process for corporates. CFOs typically favour a relatively tight roster of banks known for their execution reliability. Yet, banks aiming to boost their FX revenues must evaluate whether the potential business justifies the partnership. Corporations must also engage with a variety of financial institutions that can provide adequate credit and ensure comprehensive coverage of their FX requirements while fostering competitive pricing.

Corporations may believe the more banks they work with the more chance they have of getting the best price, but Jacquemin said this does not take account of operational considerations. “The more banks you go to, the more complex your processes are – and if it takes you much more time to execute deals, you are sitting on additional risk,” he observed.

“For the most liquid pairs, I would be very surprised if the average rate was materially different across any number of banks.” Increased counterparty diversification means greater competition, which Sinawi has accepted can improve pricing for the client. “However, it may become harder for banks to justify limited capital and human resources to expend on clients as a result,” he added.