Credit ratings come into FX focus

A recent raft of credit rating downgrades has brought the issue of forex counterparty risk to the fore. Awareness has been further heightened in recent years by banking consolidation, which has resulted in a smaller number of players in the forex market, and so a potential concentration of risk, said dealers.

Most counterparts have credit rating restrictions in terms of dealing, and controls are much tighter in the derivatives market - where contracts are long-dated - than in spot foreign exchange. Forex derivatives risk is also higher, as if left with a counterparty default, players will need to re-purchase any derivatives contracts, possibly at an inferior price. Therefore, many clients, such as central banks, asset managers and some major corporate firms, will only trade with counterparts who boast an AA rating.

"For derivatives, there would be a sensitivity below AA," said Tanya Azurchs, banks analyst at Standard & Poor's in New York. "Counterparties may ask for collateral, they may have smaller lines available and in some cases will refuse to do business." Azurchs also warned that the credit situation is unlikely to pick up in the near term.

Further downgrades could mean the banks with the highest ratings gain more forex business. "Obviously our triple-A rating is encouraging at any time, but it's a particular advantage at the moment," said a spokesperson at Lloyds TSB in London. She declined to comment on whether or not the bank had enjoyed increased volumes in the wake of recent downgrades to competitors.

"We believe our rating is a major asset and is more important than ever at the moment," echoed Christophe Bristiel, head of forex sales at AA-rated French bank Credit Agricole Indosuez in London.

Rating agencies have downgraded banks such as JP Morgan Chase, Morgan Stanley and Commerzbank during the past few months. But these investment banks are still in the double- or single-A categories and are rated higher or at the same level as many other banks.

A spokesperson for Commerzbank declined to comment on whether the bank's recent downgrade had affected its forex business. Morgan Stanley also declined comment.

But forex business at JP Morgan Chase has not been affected, said bank officials. "While we were disappointed by the recent downgrade, it has not affected our ability to deal. In fact our current rating brings us to a level consistent with many other forex participants," said David Puth, global head of forex at JP Morgan Chase in New York.

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