As the Asia-Pacific region picks up again, there has also been an increase in Asian FX trading. But, unlike most other regions, it is not necessarily the large institutional players that are exhibiting the most sophistication. Mark Pelham reports.After six years in the doldrums, the Asia-Pacific region (excluding Japan) seems to be on a genuine upswing again. Combined with the global search for yield, this is generating a renewed interest in FX trading. As in the rest of the world, FX is increasingly being used as an asset class; but, unlike other regions, those using the most advanced FX products are the supposedly less sophisticated, small corporate users and retail investors.

While Asia-Pacific may be regarded economically and geographically as a separate region, in today’s financial markets it is not so straightforward. “FX is an international business,” says Ed Hulina, global head of FX marketing at UBS Investment Bank. “The needs of FX users are more segment driven than regionally driven.”

However, he says that FX strategies need to be implemented at both the regional and local level. So, while UBS has a clear and well-articulated strategy with regard to its FX business globally, it needs to be very nimble when implementing that strategy at the local level. In Asia, for example, it will examine the local needs of clients and adapt its distribution and FX services to meet them.

Less homogeneous

A significant element of operating an FX business in the Asia-Pacific region is that there are 15 different countries and, consequently, 15 different regulatory environments and market practices. “So, it’s not as homogeneous as the North American market or even the European market,” says Gerald Chan, managing director and head of FX distribution at UBS Investment Bank in Asia.

Nevertheless, there are two significant trends affecting the region, according to Peter Redward, currency strategist for Asia at Deutsche Bank. “First, is the decline in the dollar; [this has] combined with falling yield levels to such an extent globally that money is being moved into locations with which people would not have been particularly comfortable two or three years ago. We have seen credit spread compression and moves into what seem to be relatively high risk emerging markets.”

The second factor is the recovery of the Asian region in the post-crisis environment, facilitated by increasing liquidity levels. This is partly due to both household and corporate balance sheets continuing to strengthen in the past few years. “We are seeing signs of some countries emerging quite strongly from the post-crisis environment,” says Mr Redward.

In this environment, the underlying reasons for buying and selling Asian FX have increased and are expected to continue to do so. Those underlying reasons, according to Simon Flint, senior strategist at Bank of America in Singapore, are the growing trading relationships within Asia and between Asia and the rest of the world. Larger volumes of this kind of trade increase FX trading volumes directly and, in addition, engender greater bullishness about Asian economic prospects.

“Thus we see more interest from the real money managers for portfolio investment and, in turn, greater speculative interest from the hedge fund community – suddenly Asian FX has become more interesting to a range of investors,” Mr Flint says.

However, Mr Flint believes there are still challenges ahead. “My one caveat is that the level of central bank interference in FX markets in Asia means that any gains that investors or speculators might want to see in owning an Asian FX asset could be limited compared with other asset classes.”

FX as an asset class

In any event, FX is increasingly being seen as an asset class in its own right across the region, says Nitin Gulabani, head of Asia-Pacific FX at Deutsche Bank. He says it is being led by institutional pressures. As investment trends have become more global, currency returns in turn can become a differentiating factor in total returns, which has led to a growth in active currency overlay managers.

“Additionally, since the Asia crisis, Asia savings have flown to the safety of the dollar, but now, with yields low and equity market returns recently being pretty poor in the US, they are looking for alternatives and given the relative higher returns on capital, Asian markets are becoming more attractive,” says Mr Gulabani. “There is more liquidity in existing markets and some product extension – the Indian FX options market, for example. But, perhaps most notably, we are seeing the FX product being used increasingly by the institutional market for alpha generation and predominantly individual investors to generate returns, most times principal protected.”

Dual currency deposits

Mr Chan agrees that most FX trading activity has arisen from the large private investor. “In Asia-Pacific specifically, the low-yield environment has resulted in investors using currency options as yield enhancement products. In their most simple form, this means dual currency deposits,” he says.

With such products, an investor deposits an amount of a base currency, say, US dollars, and chooses an alternative currency, say, Australian dollars. The investor effectively sells a US dollar/Australian dollar call option. If the base currency strengthens beyond the strike price at the expiry date, the investor’s US dollar converts to Australian dollar; if not, the option expires worthless, yet the investor still holds the base currency. Variations on this include range bets, whereby investors take the view that a currency pair will trade within a range and the yield is enhanced by selling double no touch options providing anywhere between 50 to 250 basis points or more in yield pick-up, depending on the tenor and implied volatility.

Furthermore, Mr Gulabani says: “We are seeing activity in even newer types of products rather than the regular currency products you expect as markets evolve. Advances have been made in products such as dual currency deposits becoming triple currency deposits and range notes becoming phoenix range notes – a double two chance range note.”

Due to increased local currency volatility, corporates have increased their hedging activities and also begun aggressively using quanto technology in swaps to manage their liabilities, says Rodrigo Zorilla, regional corporate sales and structuring head at Citigroup in Singapore. “For example, a corporate has a debt portfolio in Hong Kong dollars paying interest on Hibor and is concerned that, because the Hong Kong dollar is pegged, if there is pressure on the country most of the heat will be taken on the interest rate side.”

To avoid this risk, the corporate swaps its Hibor interest rate to US dollar Libor but wants to avoid currency risk and so needs to continue to pay in Hong Kong dollars. The quanto swap allows it to reference to a US dollar-based index without changing payments or principal of the debt from local currency. From a bank’s perspective, this creates the need for all sorts of dynamic hedging to manage the risk, thereby facilitating new volumes on the FX markets. “The use of quanto technology on the liability management side, as well as by private bank investors, is a very Asian trend,” says Mr Zorilla.

Complex instruments

Chris Willcox, Asia regional head, global rates and currencies, at Citigroup in Singapore, believes the use of such complex instruments by the non-professional sector makes sense. “In these very low-yield situations, such as we have had in Japan in the past few years, the ability to manufacture somewhat higher yield using some form of quantoing becomes something that is relevant not only to sophisticated investors, but also to consumer investors.”

Banks’ ability to offer structured FX instruments to Asian investors has been facilitated by accessible technology. Mr Hulina concludes: “The concept behind such products is fairly easy to explain; it is the pricing and booking of these instruments that is somewhat tricky. But we have been able to automate and streamline that process through web-based applications and our FX platform.”


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