Delivering on FX

Banks in the Asia-Pacific region are ramping up their proprietary electronic foreign exchange platforms in an attempt to capture a bigger slice of Asia’s burgeoning forex business. How is the shake-up in the market progressing?

There is little doubt that electronic trading is the way of the future, promising a range of benefits, including increased speed of execution, attractive pricing and straight-through processing. The migration to electronic platforms has outpaced the growth of foreign exchange trading generally which, during the height of the financial crisis, benefitted from an upsurge in volatility and increased investor demand for liquid and plain-vanilla assets.

The latest electronic foreign exchange survey by Stamford, Connecticut-based research firm Greenwich Associates, published in March 2009, found that cash and derivatives e-forex volumes worldwide surged by 37% in 2008, powering well ahead of total forex trading volumes, which grew by 13% between 2007 and 2008. Taken together, the telephone accounted for just 34% of forex trades conducted worldwide, with the remainder conducted via multi-dealer platforms (38%), single-dealer platforms (15%), messaging systems on Bloomberg and Reuters (8%), electronic communication networks (ECNs) (4%) and application programming interfaces (APIs) (2%).

Although reflective of a wider trend, these figures mask a number of important discrepancies between regions. To date, the overwhelming appetite for electronic trading has largely come from Europe and the US, where the proportion of forex traders using e-forex systems in 2008 stood at 69% and 70%, respectively, up from 64% and 67% the previous year. In Asia, by contrast, the uptake of e-forex has so far been less pronounced. In 2008, just 40% of Japanese forex traders used e-forex systems, up from 34% in 2007, while e-forex use across the rest of Asia saw no increase at all and remained steady at 46%.

These differences are not altogether surprising. Figures from the Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity by the Bank for International Settlements (BIS) in 2007 – the latest such survey available – show that in April 2007, the US dollar accounted for 86.3% of total daily forex turnover, followed by the euro, which accounted for 37% of turnover (because two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200% instead of 100%). In other words, the US dollar and euro account for around two-thirds of total forex volumes traded on a daily basis. By contrast, and by these calculations, Asia’s local currencies – excluding the yen and the Australian dollar – accounted for just 7.2% of daily forex turnover.

“Some Asian currencies are by definition far less liquid than currencies such as the euro and US dollar,” says Zaimi Hossein, head of FX and metals for Asia-Pacific at HSBC in Hong Kong. “As a result, the price discovery process is more complicated and offering these currencies, regardless of the question of whether you do so electronically or by voice, can be a challenge.”

Further complicating matters is the fact that a large proportion of Asia’s currencies are ‘non-deliverable’, meaning they are used primarily for domestic transactions and cannot be exchanged in forex markets. Market participants looking to take a view or hedge their exposure to these currencies typically use non-deliverable forward contracts (NDFs). Like standard forward contracts, NDFs fix exchange rates – usually against the US dollar – for conversion on a future date. But unlike forward contracts, there is no delivery of underlying foreign currency. The settlement of the NDF is calculated to reflect the difference between the contracted forward exchange rate and the prevailing actual spot exchange rate on the settlement date. This is then cash-settled in, for example, US dollars.

Although NDFs are part of the electronic offering of most banks today, these contracts can be prone to a lack of liquidity, which has hampered overall development of the market. “The NDF market has yet to truly take off,” says Valerie Lee, head of e-business for Asia Pacific at Société Générale Corporate and Investment Banking (SG CIB) in Hong Kong. “While demand for these contracts is substantial, a number of these currencies, including, for example, the Taiwan dollar, remain subject to liquidity constraints, which complicate the ability to manage risk.” 

But it may not be just the lack of liquidity in Asian forex markets that is holding back the shift to electronic trading. Peter D’Amario, a consultant at Greenwich Associates, puts the differences down to a combination of cultural and technological factors. “On the one hand, not every country in Asia possesses the level of infrastructural capabilities required to run reliable e-trading programmes,” he says. “On the other hand, relationship trading has deep roots in the Asian culture and there are concerns that a move to electronic trading could damage these relationships, which often provide an extremely valuable source of information.”

D’Amario says the average corporate in a country such as the Philippines may not have multiple trading screens and may largely rely on its relationship with a salesperson for trade advice. “Such a company would be reluctant to start shifting much of its business to electronic screens, which are by definition more impersonal,” he says.

This could be one reason why customers in Asia have so far shown a comparatively strong preference for single-dealer platforms when trading electronically – because they use the electronic system offered by their trusted forex provider. Single-dealer platforms are customised platforms that allow investors to execute transactions directly, with the dealer acting as principal. By contrast, multi-dealer platforms bring together a range of different sources and provide the customer with transparent price discovery. Other platforms, such as ECNs and APIs, offer customers anonymity features, but are typically reserved for the more sophisticated traders only. These different solutions reflect customers’ different requirements when it comes to electronic trading.

However, as research by Greenwich Associates indicates, one of the major global trends in recent years has been a move away from single-dealer platforms towards multi-dealer platforms. According to Greenwich’s 2008 figures, US and European e-forex customers preferred multi-bank systems by a considerable margin, with 86% of US e-forex customers opting for the multi-dealer variety, against 83% of European counterparts. By contrast, just 37% of US customers used single-dealer platforms, while 46% of customers did so in Europe. Globally, nearly 80% of e-forex traders used multi-dealer platforms, while 46% used single-bank or proprietary platforms.

Asia, however, appears to buck this trend. Across the region, 63% of e-forex customers in 2008 used single-bank platforms, just 1% shy of the 64% of customers who opted for multi-bank systems. Excluding Japan and Australia, the figures for single-bank platforms were even higher – with 74% of e-forex traders opting for single- bank systems.

“Clearly in Asia, relationships continue to carry a lot of weight,” says D’Amario, who likens single-bank systems to ‘training wheels’ for certain customers getting familiar with e-forex, but unwilling to make the move to independent multi-dealer platforms. “A single-bank platform can be a sort of half-way house, as it allows customers the benefits of electronic trading without jeopardising their relationship with the salesperson,” he says. “Once customers are comfortable dealing with single-dealer platforms, you could expect them to remove these training wheels and shift towards multi-dealer platforms.”

That was then. Today, Asia has emerged from the global financial crisis as the global economic powerhouse of the future. While Europe’s economies will have to contend with around 1% gross domestic product (GDP) growth figures, the International Monetary Fund forecasts growth for the region at just under 5%, with India and China forecast to reach GDP growth of 7.7% and 10%, respectively.

Citing the strong growth projections for the region, market participants say the outlook for forex trading – and by extension e-forex trading – has never been better. “The growth forecasts for China are expected to positively impact demand for commodity currencies across the region, as evident from the recent popularity of the Aussie and kiwi dollars, which benefits Asian currencies,” says Lee. “As a result, we expect e-business to flourish across the Asia region.” In response, during 2009, SG CIB has made 150 trading and sales hires to its flow-fixed income and currencies business globally, a significant number of which will be based in Asia.

Those expectations are matched in the interbank market, where interdealer broker Icap has made servicing Asia’s currency needs one of its strategic priorities. “At the moment, the most actively traded currencies are obviously the US dollar, euro and yen. But going forward, as the Asian economies account for a larger proportion of world trade and will become more liberalised, we do expect to see a corresponding increase in demand for these currencies,” says Jeff Ward, regional manager for Asia and Oceania at Icap electronic broking in Singapore. 

Much of this growth is expected to occur in Asia’s non-deliverable currency market. “It is quite clear there is a gap between supply and demand for non-deliverable currencies through e-platforms and this is widely considered to be an area of substantial growth going forward,” says Ramesh Swamy, head of forex sales at JP Morgan in Singapore. “I’d say the vast majority of banks currently operating in Asia are looking to increase the number of restricted currencies on their platforms. As with any developing asset class, it starts with the vanilla spot and forwards, but ultimately the aim is to offer the entire gamut of forex products on these currencies through the platforms,” he says. 

It is a view that is echoed across the market. “The NDF market exists for the very reason that there is limited access to certain emerging market currencies due to regulatory issues. Client demand for these currencies has been increasing,” says David Wilkins, head of e-forex for non-Japan Asia at Barclays Capital in Singapore. “While liquidity in these currencies is not what you would find with your average G-10 currencies, an increase in demand for NDFs should lead to improved price transparency, which in turn should improve liquidity in the future.”

However, banks looking to take advantage of NDF growth opportunities can also expect a number of challenges. Lower levels of liquidity aside, the widely divergent nature of the regions’ markets and, in particular, its currencies and regulations, make it difficult to provide a unified electronic solution. “Given the many different banking regulations and currency convertibility requirements across Asia, it is crucial for banks to develop their e-platforms across the region from the ground up, taking account of specific local requirements,” says Bertrand Lavigne, head of interest rate and forex trading for Asia Pacific at BNP Paribas in Singapore. “An approach of the type you often see in Europe, where all forex trading is directed from one centralised hub in, for example, London, is not going to work.”

In addition, although market participants say the region’s infrastructure network has vastly improved in recent years, the possibility of downtime continues to feature as an important risk, forcing electronic platform providers to have a back-up system ready to go. “Like any type of activity involving the internet, there is a risk of downtime, whether as a result of electronic failures or natural disasters,” says Michele Wee, head of e-forex at Deutsche Bank in Singapore. “Since 2003, the downtime on Deutsche Bank’s Autobahn forex platform has dropped by 99%, but a customer support back-up system is vital to guarantee continuity when dealing with unforeseen power cuts.”

On other occasions, sometimes lower levels of technological advancement have also featured as obstacles to electronic trading. “Some of the sophisticated technologies that are used by clients in Europe, such as some of the more advanced API applications, are not yet common practice in the Asia-Pacific region,” says Luke Waddington, head of fixed income e-commerce for Asia and Japan at BNP Paribas in Tokyo. “We can deliver automation, but if clients don’t have the technological capabilities or infrastructure at hand to operate these functionalities, they will not be able to use these solutions. It is not a factor that will derail the growth of electronic forex in the region, but it might temper the speed of the uptake.”

Moving forward, there appears to be little doubt the move towards electronic trading will continue and the opportunities for banks looking to take advantage of this trend are likely to be substantial. “The reality is that in the future, the number of accessible currencies will only increase,” says Simon Jones, head of e-forex at Citi in New York. “Provided liquidity does not disappear, it would be reasonable to expect steady growth levels within the forex space even if levels of volatility remain steady. If, however, volatility increases, the outlook for this market could be one of exponential growth.”