Foreign exchange trading volumes were down in 2012 and the cost of operations is rising, but there are signs that 2013 will be a more promising year for banks with the right offering.

In the immediate aftermathof the financial crisis, foreign exchange (FX) was one of the few business lines that held up well, with volumes still strong and balance sheet usage from FX relatively contained compared to the credit and equity segments. Companies and investors hedging or playing the tail risks from the eurozone crisis and sharp swings in emerging market currencies owing to risk-on/risk-off market sentiment all gave FX trading desks plenty of work to do.

But 2012 took the shine off the market a little. The sheer scale of central bank intervention in the eurozone and elsewhere, which The Banker charted in its previous FX report in October 2012, gradually calmed fears and led to remarkably low volatility. That made returns elusive for currency fund managers, as David Wigan observes on page 36.

Inevitably, lower activity by fund investors means lower business volumes for their banks. According to financial services lobby group TheCityUK, foreign exchange turnover in London, the world’s largest FX market, fell 5% in the six months to October 2012, but London’s market share worldwide actually rose from 37.1% to 37.4%. That implies a global fall in daily turnover of 5.5%.

Add to that the growing operational costs of FX markets. While balance sheet usage remains modest, the push to centralised execution and clearing means creating or joining new platforms and central clearing counterparties. As Frances Faulds explains on page 40, this not only creates costs that must be passed on to end-users. It also raises questions for banks about the regulatory capital treatment of trades such as non-standardised options that cannot be centrally cleared.

“HSBC is already participating and providing volatility pricing on multi-bank platforms and proto-SEFs [swap execution facilities] for FX options. The volumes are modest but rising, and the upward trend is clear. The US SEF rules may be diluted a little, but there is no sign they will be relaxed far enough to allow hybrid SEF and single-bank execution. So we have to prepare to provide liquidity to clients via multi-bank platforms, since they may be required to switch over to that route,” says Vincent Craignou, global head of FX derivatives at HSBC.

Asia rising

However, the picture for FX is certainly not one of unremitting gloom. HSBC’s own volumes were up in 2012, and Mr Craignou says volumes so far in 2013 have been rising strongly, both for the bank and for the market as a whole. Asia is the main contributor to that growth.

“We have expected the focus of FX trading to shift gradually from London and New York toward Asia for some time. This has less to do with regulatory reasons, since we still hope the G-20 will ensure a degree of international consistency. It is much more to do with the global epicentre of growth, and especially trade, moving toward Asia,” says Mr Craignou.

There are both temporary and permanent factors at work. One of the major temporary boosts to FX has been the new policy-making regime in Japan. As explained on page 42, this is triggering a slide in the yen and a major reconsideration of hedging and investment strategies toward a currency that was highly stable in recent years.

“Most of the yen weakness has been during European and North American trading hours, which suggests that a lot of the reaction to Japanese policy statements is coming from foreign investors speculating on what actions the Bank of Japan will take,” says Jaco Rouw, senior currency portfolio manager at $241bn asset manager ING Investment Management.

The structural growth in the international trading of Chinese renminbi represents a long-term boost to FX activity. Mr Craignou says the rise in the use of deliverable offshore renminbi for a wide range of purposes has been “staggering”. Renminbi options volumes traded through HSBC have doubled in 2012, and are on course to double again in 2013, to represent the third-most active FX options market globally. The deliverable renminbi has now overtaken its non-deliverable version in options trading, compared with a 90% market share for non-deliverable renminbi just two years ago.

“Deliverable renminbi is now ticking all the boxes. There is greater opportunity to execute hedging transactions for Asian clients especially in Hong Kong and Taiwan, where many companies operate factories on the mainland. We have seen a big rise in its use by hedge fund and real money investors as the basis for investment strategies. We are now seeing some smaller European corporates switching to renminbi invoicing and hedging their FX risk, and most recently there has been growing interest from private high-net-worth clients for deliverable renminbi-indexed notes. That spread of clients is helping to create and recycle liquidity in the market,” says Mr Craignou.

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