ROUNDTABLE - Asia's FX future
Foreign exchange in Asia is constantly in a state of transition. Technology moves on, client demands change, and even the ability to access and trade Asian currencies shifts by the day. So where is it heading? ASIAMONEY asked the senior teams of five leading Asian foreign exchange banks to look forward five years and consider the trends in play.
"The way we look at the industry, and the way we resource ourselves, is that the shape of the industry will be polarised around two ends," says Lutfey Siddiqi, managing director and head of corporate risk advisory and corporate foreign exchange at Barclays Capital in Asia. "One side has to do with efficiency of execution, and the other is derivatives. It's the bar-bell, the two ends of the spectrum, where the foreign exchange (FX) industry will converge."
It's bad news if you're a trader working in the middle. "We used to have reactive price-making for vanilla options. That can now be done on a system," says Siddiqi. "The human intervention, pure broking, pure price-making part of the business is likely to dry up."
The execution side is all about e-commerce and the move to electronic delivery. Steve Weller, Barclays Capital's managing director and head of foreign exchange for Asia-Pacific, says that 70% of its FX cash trading in Asia is now done electronically, from below 25% three years ago. "By ticket, it's an even higher number," he says – and like all big houses he believes this feeds consolidation of market share among the leaders. "It's an expensive business to run and you've got to have scale to spread those fixed costs of participation across a number of clients." Playing into the same theme, says Siddiqi, is the fact that many banks which used to be regarded as inter-banks have become user banks. "We have at least 200 banks we speak to in the region that flush liquidity through us."
Big changes are taking place already in the human resources side of the business. "During peak periods we process in excess of 60 trades a second," says David Cooney, Barclays Capital's managing director and head of foreign exchange options trading in London. "There's no possibility a human can keep up with traffic that's that frequent. If you've got some sort of hybrid between electronic price dissemination and human-based risk management it's almost doomed to failure."
That means the skill-sets of employees need to change. "It is a funny nexus of skills to be able to build these engines," Cooney says. "Spot traders don't have the quant[itative] or IT skills to do it, IT guys don't have the market experience. So what you're really talking about, and one of the changes in the industry, is people with a different skill-set: to engineer pricing systems. It's going to be run by computer scientists and engineers."
Siddiqi says that it's also going to involve people with an accounting background who are comfortable with FX derivatives. "You need to be able to look at the reporting dimension, mark to market," he says. "The skill-sets required in the future world of FX will have to be very different. In my experience accountants seemed to have a mental block when it came to derivatives and vice versa. Now people who can combine these two skills are very much in demand."
Barclays sets great store by its Barx trading system, but the bank accepts that technological development will continue. "The market is growing at roughly a 20% compound annual growth rate, and Barclays' FX business has been consistently outstripping this," says Weller. "It tells you we have to be preparing ourselves for potentially a lot more flow and a lot more tickets."
The behaviour of customers is also going to drive the business. "Asian corporates have internationalised very quickly," says Siddiqi; they have become major acquirers cross-border, while export and import volumes with the rest of the world have risen sharply. For this and other reasons international portfolio managers are taking more interest in Asia, private funds have been shifting from Europe to Singapore, and offshore hedge funds are transacting more business here, all driving G10 currency volumes in Asia. Even retail is getting involved. "More and more we are seeing the man in the street trading FX as an asset class in its own right on margin," says Weller. "It's helping to fuel the outperformance of Asia in terms of growth."
"All banks will be looking at a different customer base," says Lee Lung Nien, Citi's managing director for foreign exchange sales for Asia. "Traditionally it's always been the big players – the huge multinationals, top-tier local corporates, hedge funds and banks – that most people are looking at for foreign exchange business. The trend is increasingly to look further down the market, to the SME [small and medium-sized enterprise] segments." Banks are already setting up teams to attract those clients.
Citi has seen its options business treble in three years and expects more growth in complex structures. "A lot of FX products link to an index," says Lee. "Now there are more complicated hybrids, linked to the performance of commodities, equities or interest rates. Option ideas are being pushed out across the board." These, too, are reaching the newer, smaller client base.
Jeremy Amias, head of fixed income, currencies and commodities for Citi in Asia-Pacific, expects changing regulation to fuel growth. "For traditional institutional investors, the regulations around FX have been quite heavy," he says. "As they become less restrictive, business can grow exponentially."
He sees evidence in a variety of places: Korean and Taiwanese institutional investors being allowed to invest more assets abroad, but with a requirement to hedge the currency exposure; Taiwanese insurers selling Korean won or other third party currency forwards against US dollar assets for the correlation and to save costs; and Chinese corporates having their restrictions reduced. "You're going to see an explosion across all client bases."
The opening regulatory environment that will drive industry growth will also make it more competitive. Citi has done well historically through the extraordinary range of countries in which it holds licences. "At the moment as Citi we have first-mover advantage over most other foreign banks," says Lee. "Five years down the road it's going to be a bit more open than it is now."
Amias's role unusually covers not just FX but commodities and fixed income. Despite that, he is still a big believer in specialists. "Being a master of everything is not a good recipe, in my view," he says. "You want hard-core specialisation in rates or currencies or derivatives. But we do need clever products which combine all these things. It's interesting that clients are looking for more sophisticated hedging techniques that will look at all their assets and risks."
Amias differs from some others in how he sees the changing skill-set for FX businesses. "It's not totally rocket scientists now," he says. "A fair amount of the FX market is plain vanilla." The team does use accountants, former oil traders and a host of business backgrounds, but it's not a revolution. "It's trendy to say the whole thing is changing, but it's not changing that much. Clients will deal with whoever gives them good advice."
Clifford Cheah, the bank's managing director and head of global finance and foreign exchange for Asia, is confident that liquidity will drive change in Asian foreign exchange.
"Liquidity in Asian currencies has never been as good as that in G7," he says. "But volumes in the cash markets in Asian currencies have increased dramatically. What that allows for is increasing sophistication of products, and one trend you are going to see is more sophisticated FX products appearing in the Asian currency markets."
Aside from cash, rising product complexity is already becoming clear in Asia in derivative products. "You are seeing more second-generation, advanced structures in Asian currencies," he says. And it's in evidence with electronic trading, until recently the preserve of G7 currencies, gaining momentum both in Asian cash currencies and in non-deliverable forward (NDF) currencies too. "That's a function of liquidity in the markets improving and growing."
Early evidence has been in the Korean won and Singapore dollar, "but even with currencies like the Indian rupee, which was lagging behind two or three years ago, the volumes have now grown significantly," adds Cheah.
Two Asian currencies – the Malaysian ringgit and the rupee – are undergoing gradual liberalisation, as are other currencies. Five years from now, could we expect to see unimpeded offshore trading of both those currencies and the renminbi too? "That's a big question," says Cheah. "It's reasonable to have expectations that it will happen. India and China have shown they clearly understand what their needs are domestically. The key is, if they are confident and comfortable that a freely trading currency would be good for their own domestic needs, they will do it."
If it happens, expect a transforming effect on Asian FX businesses with obvious increases in volumes but also sophistication of products. "So far what's capped development of many products are the regulations around them. With that going, you would expect to see much more sophistication."
Cheah already sees increasing interest in intra-Asian currency pairs, such as Singapore dollar-ringgit, reflecting the increases in intra-Asian trade. He thinks the electronic side has much further to go. "Investment in technology can only grow," he says. More derivatives, and currency pairs, will find their way on to electronic systems and speed will continue to improve. "Speed is all about perception: when you're sitting in front of a computer three seconds seems like an eternity. We will continue to be amazed at how speed improves."
Like others, Cheah notes the human resource challenge. "Traditionally you might have talked about a guy who is super IT-literate on one side, and on the other a person who fully understands the traditional buy-sell relationships between banks and their clients. Now you need them to understand both aspects: how technology will change the FX markets, and with the commercial understanding to benefit."
Monish Tahilramani, head of regional trading at HSBC, says three trends stand out in Asian foreign exchange: the growing share of fund business, including speculative hedge funds; the increased involvement of private banking and retail interest; and the growing activity of European and US investors in emerging market Asia. He expects all three to continue.
Retail in particular is becoming a powerful theme. "Margin trading has really caught the fancy of Japanese investors, who are increasingly looking to diversify their savings into high-yield currencies," he says. "That has been attributed as one of the biggest factors for the resumption of the yen carry trade after the massive unwinding in February."
It will also drive product development, as much of that investor base wants access to currencies that do not trade freely offshore. "Being able to offer access is clearly one theme that's coming out, both in non-guaranteed and occasionally in capital guaranteed structures," he says. "It's now quite easy to have a structure which gives investors a rate FX play into a country like Vietnam, but an appropriate wrapper and the possibility of a reasonable exit are as important."
That continuing requirement means banks will not just have to be good at structuring but the follow-up work, providing mark to market, sending research and offering market colour. Tahilramani sees investors looking further a-field for yield, to places such as Sri Lanka and Mauritius.
Another theme he has noticed is that central banks seem less willing to telegraph their intentions ahead of monetary policy changes, reasoning that it neutralises the effect if everyone already knows that it's coming. "There is an increased emphasis on unexpected policy actions," he says, noting that each of India, the Philippines, Indonesia, Korea and China have surprised the market with monetary policy in the last nine months. "They're not only tightening or reshaping monetary policy, they're doing it in a more unexpected fashion than they did before, resulting in a lot of volatility."
While doing so, though, they are allowing market forces to move more freely. Tahilramani points to India, where long-term central bank policy has been to try to limit appreciation of the currency and reduce volatility. More recently, seeing the scale of inflows coming in, they decided to let it appreciate. "Not only is it an antidote to inflation," says Tahilramani, "but they want it to get to a level where they no longer believe it is a one-way bet, where from that level it could move both ways." That's another trend to look out for in the future.
Richard Leighton is the global head of FX for Standard Chartered, based in London, and finds much of his time spent in the buoyant Asian market. He sees two key themes in Asia: e-commerce, which is a global trend with some facets peculiar to Asia, and the deregulation and liberalisation of Asian markets.
"Any initiatives in e-commerce completely change the role of the trader going forward," says Leighton. "The role in five years time will be very different to now and it's already changing. The main reason is that a big chunk of the job has been about price distribution and market-making; e-commerce takes away a lot of that role and puts the focus more on risk-taking ability."
In practice, that means more and more own-account trading can be expected, with a better linkage between the trader and the customer. "I'm not saying we're going to do away with the sales function, but sophisticated clients are looking more and more for a risk partnership with their lead banks." E-commerce will also allow more Asian currency delivery. "At the moment it is still pretty difficult to trade some NDF products," says Leighton.
He also notices the increasing role of retail in foreign exchange, and finds that to be one area where Asia does differ from the west. "Retail wasn't something anyone was talking about five years ago," he says, "but that market is growing, whether it's through retail clients doing DCDs (extendable dual currency deposits) or premium currency deposits. Asia is more active than anywhere in that space, and the growth of the retail market will be extremely important for the growth of the foreign exchange market in Asia." Alongside it, he expects to see a greater contribution from local Asian hedge funds.
Deregulation is the other driving force. "It's clear that the market is overly regulated to a large extent," he says. "None of the central banks or regulators want to rush into deregulation: they've seen the pitfalls of doing so in the past and that breeds caution."
Clearly, outside of Thailand, the direction is to remove restrictions – in Malaysia, Korea, India, the Philippines – and "things are going in the same direction, but incredibly slowly". In India, he expects exotic options in the rupee, probably at least a year from now.
China's pace of change will have a big impact on business development. Standard Chartered's economists project a 4% appreciation per year for the next five years, but change is coming at China's own pace. "One example is FX options in onshore China," Leighton says. "That feels like it's been imminent in terms of launch for a while now, but there's still not approval to do it."