Mapping the FX opportunity in emerging markets

As global capital flows change shape, the foreign exchange (FX) business is changing with them. The latest triennial survey of global FX dealers by the Bank for International Settlements (BIS) shows emerging market (EM) currencies accounting for a growing proportion of trading volumes. And smaller banks were the clients for a quarter of volumes traded by the dealers that responded to the survey.

EM corporates and investors are increasingly looking beyond their own borders. Their expanding local banks are following them, offering FX services to cater for their clients’ evolving needs. That in turn drives EM banks to trade FX more actively with the global market-makers.

Increasing demand

Using the unparalleled network of EM banks built during the 40 years of compiling our Top 1000 World Bank rankings, The Banker has launched its own survey to assess the changing FX needs of this client base, and their preferred global bank counterparties. This first survey received more than 50 extensive responses from across Africa, Asia-Pacific, emerging Europe, Latin America and the Middle East, and we hope to continue expanding this group each year.

The most striking finding is the general increase in demand for FX transactions among EM banks. Across the dollar, euro and yen, on average 54% of respondents reported an increase in their needs, compared with just 10% reporting a decrease. The euro saw the largest proportion of respondents reporting reduced usage, but even that was only 15%. Africa is clearly the growth region, with more than 90% of respondents showing an increased need for dollar FX trading. By contrast, less than 60% of Asian banks reported an increase in dollar trading, while 18% reported a decrease.

Much has been written about the internationalisation of the Chinese renminbi. Only 1% of respondents reported a decrease in renminbi trading, compared with 28% recording an increase. However, the scale of the opportunity is clear, with 59% of EM banks not yet trading in renminbi. This compares with 21% for the yen and just 9% for the euro, while all banks recorded dollar FX needs. Unsurprisingly, Asian banks show the highest rate of renminbi uptake at 71% of respondents. At the other end of the scale, only 36% of African banks report using renminbi transactions, which suggests an opportunity for growth given China’s well-publicised investment in Africa.

The dollar evidently remains the currency of choice for FX transactions, growing in demand much more sharply among respondents than any other currency. Even on the yen, which has experienced greater volatility this year owing to a new monetary policy framework, only 46% of respondents recorded increased transaction needs. The BIS survey records an increase in the dollar share of average daily transaction volumes to 87% in 2013 from 85% in 2010.

Choosing a counterparty

Pricing is by some distance the most important criteria among EM banks when it comes to choosing a counterparty for trading FX. In total, 63% of respondents worldwide selected it as the top of the four criteria included in the survey. The other three criteria proposed were the credit rating of the counterparty, the quality of advice and structuring, and a local presence for the global bank. A local presence was first choice for less than 4% of EM banks, while 72% recorded it as their least important criteria. Counterparty credit rating came in as the second most important factor, only just ahead of the quality of advice.

The exception to the rule appears to be frontier markets, where banks have a much stronger preference for trading with a counterparty that has a local presence. Banks in Pakistan, Kenya and, in particular, Vietnam considered a local presence as their most important factor. This may indicate the challenges for FX desks of persuading credit committees to approve trading lines for the least familiar markets. It plays to the strength of banks with a frontier market presence, and Standard Chartered has a particularly strong showing in these three countries.

Overall, banks in the Middle East appear to be the least sensitive to pricing as a region, with less than 45% of respondents identifying it as their top criteria. Instead, they appear more concerned about counterparty credit rating, which was the strongest factor for all of the other 55% of respondents. Africa was the region where respondents appear to place the greatest emphasis on the quality of advice and structuring received. This category garnered 28 points in Africa, fractionally ahead of counterparty credit rating.

A number of respondents indicated other criteria that were important in choosing a counterparty and we will include some of these in the next survey. Most prominent were the EM banks’ own limits on exposure to any one global bank, the maximum duration of trades offered by a global bank and the strength of the client’s relationship to the investment bank across other financial products.

Consolidated market

The BIS triennial survey remarks on the increased consolidation of the FX market that is reducing the volume of trades between large dealers. That concentration is also visible in our sample, with Citi having a share of almost 11% among all the counterparties listed by respondents, more than three percentage points ahead of second-placed Deutsche Bank. The US giant also stands out alongside Standard Chartered for winning market share in frontier markets across a range of regions, from Vietnam to the Dominican Republic via Kenya. Emerging Europe is possibly the region where Citi’s coverage is thinnest, focused on the core markets of Russia and Turkey.

Of the five EM regions, Citi comes top in Africa, Asia-Pacific and Latin America, with two of the top five globally (JPMorgan and UBS) accounting for the Middle East and emerging Europe, respectively. Market share tails off rapidly outside the top 10, with South Africa’s Standard Bank coming in at 15th thanks purely to the strength of its franchise in Africa. No bank reported it as a counterparty outside Africa.

Standard Bank has the second largest market share in Africa behind Citi, running almost two percentage points ahead of third-placed Deutsche. Africa is also the only region where Barclays – which owns Absa Bank in South Africa – features among the top five. In a similar vein Standard Chartered, which runs its global FX team from Singapore, takes a strong second place in Asia. These performances suggest that, although respondents did not rate local presence as particularly important, regional brand recognition in reality has a certain power in winning clients. However, the regional strength of Raiffeisen and UniCredit in emerging Europe appears less helpful to their FX franchise: both have a larger market share among African banks than in their core area. Raiffeisen is also stronger in Asia, while UniCredit picks up more votes in the Middle East.

China champions

In terms of currency market share, it is noticeable that eurozone banks do not perform particularly strongly in euro FX activity. Only one, Deutsche, appears among the top five. Excluding Deutsche Bank, another 13 eurozone banks have a euro transaction market share of just 18.8%, compared with the 16.5% share for six UK banks and 11.3% for four Swiss banks. Citi and JPMorgan are rather more dominant at the top of the dollar rankings, although the third placed US bank, Bank of America, comes in a distant 10th, behind eurozone stalwarts BNP Paribas and Commerzbank. Goldman Sachs actually has a larger market share in euros or yen than in dollars.

Perhaps the most striking weakness, however, is the absence of any Japanese bank from the top 10 yen counterparties in emerging markets. Bank of Tokyo-Mitsubishi UFJ has the largest share in yen of any Japanese bank, at just 3.4%. The Japanese players have the largest pool of natural yen liquidity, but presumably do not cultivate EM banks as clients. Foreign banks have stepped into the breach in this freely traded currency.

By contrast, the protected nature of the Chinese currency market provides a clear advantage for China’s banks in renminbi trading, and two – ICBC and Bank of China – feature among the top five. HSBC has established a very strong lead in trading renminbi among EM banks. The currency also seems to provide an interesting opportunity for Australian banks – they have a total market share of 3.9% in renminbi, larger than JPMorgan.

The importance of pricing as a criterion for choosing counterparties means the traditional approach of using a fixed panel of investment banks for all their needs appears relatively weak among FX clients. While the leading investment banks have a strong presence for all currencies, very few respondents appear to run an identical panel for every currency. The exception is the Middle East, where almost 80% of respondents reported the same panel of counterparties across all currencies. This is consistent with the fact that pricing is a lower priority among Middle Eastern banks.

Leading banks headquartered in emerging markets are comparatively sophisticated users of financial instruments. A number in this survey, especially in Asia, are moving beyond global investment banks in their search for best execution. Several report the use of exchange-based or multi-dealer trading platforms for transacting the most liquid currencies, such as dollars and euros, and this is a trend we may track in future surveys.