Emerging market FX still in demand

Expectations that US quantitative easing would begin to taper in the final quarter of 2013 have led to a sharp strengthening of the US dollar against many emerging market currencies during the first half of the year. This even threatens to cause macroeconomic turbulence for some of the most affected emerging markets. But the cyclical fall in emerging market exchange rates should not disguise the deep-seated structural trend – emerging market currencies are moving rapidly from the fringes of the foreign exchange (FX) business to its core.

The triennial survey of FX markets by the Bank for International Settlements (BIS), a snapshot taken in April 2013, shows two emerging market currencies, the Mexican peso and Chinese renminbi, entering the top 10 most traded worldwide for the first time. The total volume share of the most traded 10 emerging market currencies – Russian rouble, Singapore dollar, Turkish lira, South Korean won, South African rand, Brazilian real, Indian rupee and Polish zloty, as well as the Mexican peso and Chinese renminbi – rose to 14.2%, compared with 9.9% in the previous survey in 2010. This increase in volumes goes hand in hand with the expansion of emerging market currency trading onto electronic platforms previously limited to the most liquid developed market currencies.

“What we are seeing is an expanding matrix of both products and currencies trading electronically. More currency pairs have good liquidity on electronic platforms, and more of the suite of derivative products is trading electronically, not just plain vanilla FX,” says Kevin Rodgers, global head of FX at Deutsche Bank.

Emerging trend

The more diverse FX business favours banks with a well-established emerging markets footprint. Standard Chartered has always had a strong presence as a balance sheet corporate lender in Asia, the Middle East and Africa. Now the bank is looking to develop its healthy transaction banking franchise into a more extensive suite of FX products.

“We will never operate as a traditional investment bank, but we know that internalising flow is the key to a successful FX formula. That means cultivating an institutional investor client base to take the other side of corporate deals,” says Chris Allington, global head of FX at Standard Chartered, himself a veteran of pure-play investment banks such as Goldman Sachs and Merrill Lynch.

The BIS survey shows that inter-dealer FX trading has fallen to 38.7% of the total in 2013, compared with 63% in 1998 when the first survey was conducted. This is a sign of the way that increased concentration in the FX business has enabled the leading players to internalise a high proportion of their flows. Moreover, the share of non-financial counterparties – essentially the companies using FX deals to hedge their exchange rate exposure – has also dropped sharply, from 17.4% in 1998 to 8.7% in 2013. That trend highlights the importance for a traditional corporate bank such as Standard Chartered to tap into the growth area – financial institutions other than the global FX dealers who are the respondents to the BIS survey.

The most important sub-segment of this category is smaller banks, which now account for 24% of business at the largest FX dealers. This suggests that local emerging market banks are increasingly providing for the FX needs of their corporate customers directly, then hedging their own exposure in the market. Given the growing importance of this business, The Banker has conducted a survey among its own network of editorial contacts in emerging market banks to identify their needs and their preferred global bank counterparties (see page 48).

Electronic offering

Another 22% of volumes for FX dealers are with institutional investors and hedge funds, the group that may be particularly focused on electronic platforms. To cultivate that client base as well as increasing its corporate client flows, Standard Chartered has established an electronic platform of its own. The intention is to distinguish this platform from the most sophisticated electronic players such as Deutsche Bank and Citi, by offering the broadest selection of emerging market currencies.

“Our aim is eventually to build it into a holistic local-to-local emerging market offering, including all aspects of fixed income, currencies and rates. Our clients will be able to buy emerging market local market debt and hedge the FX exposure offshore on one platform,” says Mr Allington.

However, opinions vary on the limits of electronic trading. Mr Allington believes an over-reliance on e-commerce can cause a bank to lose some of its service quality, especially for more idiosyncratic markets such as those in sub-Saharan Africa. But for Mr Rodgers, electronic trading can go hand in hand with better advice.

“Electronic platforms increase the productivity of our FX business, and that frees up human time to solve specific problems for clients. We have more time to advise on matters such as balance sheet hedging, rather than spending all day on executing trades. The staff today are more experienced and more hands-on with their clients’ needs than when I started out in this business,” says Mr Rodgers.