INSIDE How the foreign exchange market emerged from the ...

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INSIDE How the foreign exchange market emerged from the ...

FOREIGN EXCHANGE

FINANCIAL TIMESSPECIALREPORT | TuesdaySeptember 29 2009

Staying in gear

INSIDE How the foreign exchange market emerged from the

financial crisis with its reputation enhanced

www.ft.com/foreign­exchange­sept2009


2 FINANCIALTIMESTUESDAYSEPTEMBER 29 2009

Foreign Exchange

In This Issue

The future is imperfect

FORECASTING It has been equated with

flipping a coin, ridiculed by Alan Greenspan,

and is universally thought to be the least

successful sort of financial forecasting out

there. How do currency strategists stand it,

asks Jennifer Hughes Page 4

Strategist adds risk to his portfolio

PROFILE OF STEPHEN JEN Jennifer Hughes

meets BlueGold Capital’s man of many parts,

who joined the company in May after

several years as a currency strategist for

Morgan Stanley Page 5

Internet brings power to the people

RETAIL INVESTORS Peter Garnham explains

how technology has opened the market to

some surprising participants including

day­trading Japanese housewives Page 7

Return of the hedge funds

MARKET TRENDS Hedge funds were the

fastest­growing power in the market before

the credit crisis, and now they are beginning

to return, writes Jennifer Hughes Page 7

More articles on FT.Com

Getting that swinging sensation

VOLATILITY Sharp movements up and down

returned to the FX markets at the start of

the financial crisis, writes Peter Garnham.

But as the global economy recovers, volatility

is likely to return to more typical levels

Eruption leaves its aftermath

TRADING VOLUMES The evidence suggests

that FX volumes have suffered in the

aftermath of the financial crisis, writes

Peter Garnham, but most believe the market

remains in good health. See articles at:

www.ft.com/foreign­exchange­sept2009

FrontPageIllustration:MEESON

Contributors

Peter Garnham

Currencies Correspondent

Jennifer Hughes

Senior Markets

Correspondent

Andrew Baxter

Commissioning Editor

Steven Bird

Designer

Andy Mears

Picture Editor

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contact: Chris Nardi

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@ft.com or your usual

representative

Keeping

its head

as others

lost theirs

OVERVIEW

Peter Garnham on

how the world’s

most dynamic

market weathered

the credit crisis

and its aftermath

The foreign exchange

market has emerged

from the financial

crisis with its reputation

enhanced.

In the turmoil following

the collapse of Lehman

Brothers last September, the

deep liquidity in the world’s

largest financial market

offered hard-pressed investors

a lifeline as other markets

seized up.

Only in the FX market,

which kept trading throughout

the turbulence, was

there the opportunity to

hedge lossmaking positions

with big macro-economic

bets.

This brought an unprecedented

sharp increase in

volumes, attracting new

investors to the world’s

most transparent and

dynamic market.

“When the world blew up,

we remained open for business,”

says Richard

Leighton, global head of FX

at Standard Chartered.

It was not just that the FX

market was open for business,

it was open 24 hours a

day, allowing investors to

react immediately as the

next shoe dropped.

Jas Singh, global head of

Treasury at Thomson Reuters,

says one of the reasons

that there was no dislocation

in the FX market was

that banks had already

taken steps to address settlement

risk – which is the

chance that one party to a

trade pays out the currency

that it has sold but does not

receive the currency it has

bought – by introducing the

Continuous Linked Settlement

Bank, or CLS.

Since 2002, CLS, which

settles more than half of global

currency trades, has

matched trades and netted

each participating bank’s

daily FX exposure.

Calminacrisis:aTokyocurrencytrader Bloomberg News

“FX is a poster child for

how over-the-counter financial

markets should work,”

says Mr Singh.

But as other markets

came back to life, those unusual

trading flows receded,

and trading volumes fell on

the back of a slowdown in

global trade and as hedge

funds drew in their horns.

Banks estimate that trading

volumes are down about

25 to 30 per cent from their

highs in the immediate

aftermath of Lehman’s collapse.

But that still leaves volumes

above 2007 levels,

when the last comprehensive

survey from the Bank

for International Settlements

estimated average

daily turnover had risen to

$3,200bn, up 71 per cent

from 2004.

As the global economy

picks up, many believe volumes

will continue on their

upward trend. Interest in

currency trading from retail

investors continues to soar,

while hedge funds are now

returning to the market.

Retail investors have

indeed become much more

active, driven by improvements

in technology. The

internet has allowed individual

investors access to

greater liquidity and tighter

trading spreads, while electronic

trade processing has

simplified risk management.

Furthermore there has

been an explosion in trading

Concern over scope of initiatives

REGULATION

Jennifer Hughes

looks at the impact

of proposals aimed

at other markets

Unlike other markets, FX

did not break down during

the crisis. In fact, it kept

working steadily, providing

one of the essential cogs

that kept the financial system

going through one of its

darkest periods.

Yet regulatory initiatives

in the US and elsewhere,

designed to address problems

in other corners of the

trading world, are threatening

to sweep up FX in ways

that market watchers warn

could change how a whole

range of market participants

do business.

“We’ve really had to work

to alert our clients,” says

one banker. “Many customers

didn’t understand that

they were being lumped

together with the AIGs and

monoline insurers of this

world and they’re only now

seeing the risks.”

The most immediate danger

to the FX world comes

from US legislative proposals

to push all standardised

derivatives through clearing

systems. This would potentially

require higher collateral

for non-standard trades

in an effort to dissuade participants

from dealing outside

the closely regulated

exchange world.

Currencies are, however,

largely traded over-thecounter

in bilateral deals

between market participants,

which include banks,

central banks, institutional

investors, hedge funds and

companies.

So-called “spot” FX – for

immediate delivery – makes

up just under a third of the

total market, where some

$3,200bn is traded daily,

according to the Bank for

International Settlements’

2007 triennial survey. Swaps

make up just over half the

market and forwards comprise

the remaining 11 per

cent.

Currency hedging is one

of the most used corporate

risk management tools.

Bankers and corporate

treasurers are warning that

most of the contracts they

use are not standardised.

Even a proposed exemption

for physically-settled

spot and forward contracts

would not cover most companies’

dealings, some have

warned.

“That’s a very narrow

range of transactions,

because there are a whole

variety of other tools used

by companies and they

wouldn’t be covered, as it

stands,,” says Mark Lenczowski,

associate general

counsel at JP Morgan.

“Perhaps you have a customer

who wants to do a

forward deal but doesn’t

have certainty on delivery

of the other currency, so he

wants some optionality. Or

a customer wants to extend

a contract. Banks can handle

these changes, but those

kind of amendments would

kick the deals out of the

exemption if this bill

becomes law as it stands.”

Market players already

have the option to use

standardised, exchangetraded

products via the Chicago

Mercantile Exchange,


y individuals using computer

generated high-frequency

trading models that

previously were the exclusive

domain of professional

investors. Easily downloaded

from the internet,

the “buy” and “sell” signals

generated by these systems

are now influencing prices

in the wider market.

Meanwhile, prime brokers

report increased demand for

their services from recovering

and newly-formed hedge

funds.

Many of these new funds

are run by former proprietary

traders at leading

banks, which turned away

from risk in the aftermath

of the financial crisis to concentrate

on making higher

returns from their customer

order flow.

‘It is a highly liquid

market that

withstood last

year’s shocks and

that is good for

investor confidence’

Those returns soared as

spreads widened in the

wake of the financial crisis.

Indeed, a renewed focus

from banks on their core

businesses in the wake of

the financial crisis has

upped the ante in the FX

industry, with a renewed

push of investment into the

sector, particularly in electronic

trading, helping to

heighten competition among

leading liquidity providers.

Critical mass will be crucial

in this new environment.

Higher profits will

depend on an increasing

ability of banks to internalise

their order flow by

matching customer deals

against one another, thus

lessening the need to go out

which has rapidly expanded

its product offering in

recent years and enjoyed

strong growth in volumes.

However, the ongoing

strength of the OTC market

suggests the whole FX

world sees no reason to

head to an exchange just

yet.

The changes being proposed

are particularly

alarming to the FX market

because it sees itself as distinct

from other asset

classes as a result of its

unique position as an essential

cog in the global payments

system.

It is used to effective, but

quiet, oversight from the

world’s central banks, not

the glare of the political

spotlight.

It was the central banks

that in the 1990s forced the

market to face up to its

greatest risk – that of settlement,

not clearing, which

covers the period between

trading and settlement.

It is settlement risk that

into the market and pay a

spread to balance a position.

This chase for market

share could provoke further

concentration of FX trading

at the leading banks, where

the top 10 institutions

already account for about 80

per cent of market activity.

In a further twist, many

believe that the market as a

whole may get bigger in the

wake of the crisis as

renewed risk appetite leads

banks to restart their proprietary

trading operations.

Meanwhile, reduced levels

of volatility should see

activity in the FX option

market come back to life.

The market suffered in the

aftermath of the financial

crisis as massive deleveraging

and increased uncertainty

prompted an unprecedented

rise in the cost of

insuring against currency

moves.

But David Gershon, chief

executive of Superderivatives,

the London-based

technology firm that provides

independent valuations

of derivatives, says

interest in options is on the

rise.

“A pick-up in activity is

going to happen gradually,

but the reason for it is simple,”

he says. “Nobody feels

comfortable about where

currencies are going, you

have to hedge.”

Indeed, Icap, the world’s

largest inter-dealer broker,

says that as the global economy

starts to improve, it is

seeing volumes coming back

on EBS, its electronic FX

dealing platform.

David Rutter, deputy chief

executive at Icap, says the

FX market – a market of

natural hedging interest to

a variety of investors – is

not dead by any stretch.

Indeed, he says, the currency

market is showing

quite a bit of life.

“The FX market will

matters most for FX

because of the huge sums

involved in the spot market,

where minimum trades are

normally 1m currency units

and a single bank’s daily

exposure can outstrip its

entire capital base.

The result was Continuous

Linked Settlement, or

The market is used

to effective, but

quiet, oversight

from central banks,

not the glare of the

political spotlight

CLS, a daily system that,

since 2002, matches trades

and nets each participating

bank’s spot FX exposure. If

a trade is not matched, the

payment is not made, taking

out the age-old risk that one

bank would hand over its

funds before getting its payment

in return.

160

140

120

100

80

60

Apr 2008 2009 Aug

800

600

400

200

Foreign Exchange

Average daily spot values of major currency pairs Average daily volumes and values*

April 2008 = 100

Average daily volume of trades (’000)

Value ($’000bn)

A$/US$

£/US$

Euro/US$

US$/C$

US$/Yen

Source: CLS Photo: Alamy

prove to be amazingly resilient,”

he says. “It is a highly

liquid market that withstood

last year’s shocks and

that is good for investor

confidence.”

He believes the FX market

has found a base and now

confidence is returning.

“We are not worried about

the health of the marketplace,

we are looking at

where we are positioned in

that market place,” says Mr

Rutter.

“Banks are of course looking

again at all the risks

they run and they’re definitely

looking at pre-settlement

risk and the potential

need for longer-dated FX to

be cleared, but I don’t think

they see it as the biggest

issue for FX,” says Rob

Close, chief executive of

CLS.

“But if market participants

– or the regulators –

want clearing, then we’ll be

there as part of the solution.”

The CME already settles

its FX trades through CLS

and sees an expanding role

for clearing in the market

as growing numbers of companies

and investors use

longer-dated contracts.

“With a two-day dollaryen

deal, there’s not a lot of

pre-settlement risk. But a

five-year dollar-Polish zloty

swap? There’s risk there

that someone might want to

manage,” says Derek Samman,

head of FX at the

CME.

0 0

Apr 2008 2009 Aug

* These values are the total value of settlement instructions submitted to CLS on trade date.

The values should be divided by two for spot and forward values and by four

for swap values to equate to the values reported in the BIS tri-annual surveys

5

4

3

2

1


4 FINANCIALTIMESTUESDAYSEPTEMBER 29 2009

Foreign Exchange

Where the future is imperfect

FORECASTING

Jennifer Hughes

unwraps the

mysteries of an

inexact science

It has been equated

with flipping a coin,

ridiculed by Alan

Greenspan, and is universally

thought to be the

least successful sort of

financial forecasting out

there. How do currency

strategists stand it?

Quite well, it seems.

”What I like about FX is

although our forecasting

ability is actually as bad or

good – depending on your

point of view – as the others,

people have this preconceived

idea we’re worse, so

they expect less of us,” says

David Bloom, head of FX

strategy at HSBC. “We’d

argue all markets are as

unforecastable as each

other.”

That’s not what Alan

Greenspan said. The former

chairman of the Federal

Reserve, nicknamed the

Maestro for his power over

the markets, once told Congress:

“There may be more

forecasting of exchange

rates, with less success,

than almost any other economic

variable.”

HSBC, however, went on

to analyse the performance

of currency forecasts

against predictions for both

stock markets and interest

rates. Controlling – as much

as was possible – for the different

factors in each, it

concluded that consensus

FX forecasts were not a

good basis on which to

trade, but were no more

unreliable than the others.

“In our equity sample,

only 3 out of 50 had the market

falling. In FX, we get it

wrong, but we’re unbiased.

Equity guys are biased and

bad predictors. We’re just

bad predictors,” says a triumphant

Mr Bloom.

Currency markets are a

key part of economic theory,

but hands-on analysis got

going only after currencies

began floating freely in the

1970s.

Initially, analysts were

economists schooled in macroeconomic

theory. For currencies,

this centres around

relative interest-rate differentials,

which should drive

currencies higher or lower,

depending on who has the

higher interest rates.

However, over the past

decade, “analysis” has

largely morphed into “strategy”.

Technological

advances have opened the

FX markets to forces such

as institutional investors

and hedge funds. Most still

want some medium-term

macroeconomic view of currencies,

but increasing num-

‘People have this

preconceived idea

we’re worse,

so they expect

less of us’

bers, led by fast-moving

hedge funds, want specific

ideas they can trade.

“It’s all part of the service

now, and can be invaluable

to the investor who may

have formed his own opinion

of the probable direction

of the market, but may lack

the expertise or experience

to choose the most effective

trade to successfully express

this view,” says Nick

Beecroft, consultant to Saxo

Bank.

The good news for investors

is that the sheer size

and depth of the market

means there is an almost

endless pool of potential

trade ideas.

The tough part for strategists

is that to have successful

trade ideas, they still

have to be able to call the

market direction. With some

$3,200bn worth of currency

traded daily around the

clock, that can be hard. Participants

in the market

range from central banks

and governments through

companies going about their

daily business to fund managers

and bank traders.

None of these groups are

necessarily driven by the

Greenspan:notafan

same motivations, leaving

strategists walking a tightrope

between their economic

training and the need

to understand market fads.

“Its always alive and

always different,” says

Stephen Jen of BlueGold

Capital Management. “You

have to be street smart as

well as book smart to apply

the right tools at the right

time because there are different

drivers of the market

at different times.”

Currency strategy today

does not really have an

agreed framework like other

assets classes. Equity strategy,

for example, is driven

by valuations of each company.

“Bonds, commodities,

stocks – they’re all like looking

through a key hole. Currency

market analysis is

like having a picture window

to look through,” says

Marc Chandler, head of FX

strategy at Brown Brothers

Harriman in New York, who

believes clients can accept

wrong calls so long as the

strategist has an opinion

and can back it up.

“A broken watch is still

right twice a day,” he says.

“Most participants in FX

aren’t profit-maximisers,

they’re companies and fund

managers who need to

hedge. For them getting it

right isn’t ‘buy now, sell

later’, it’s about understanding

the risks involved and

the best tools to deal with

those.”

The trials and tribulations

of FX analysts are continuing.

The dollar has been in a

long-running downtrend

since 2002 as the market has

fretted about the need to

finance the yawning US current

account deficit.

After the collapse of Lehman

Brothers in September

2008, most expected the

greenback’s slide to pick up

pace as investors considered

its flattened financial sector

and stayed away. Not so;

the dollar turned into a socalled

“safe haven” as US

investors repatriated funds

and others seemed to take

the view that if the US was

in deep trouble, others were

in even deeper.

Since then the dollar has

broken its traditional link

with the US stock market

and currently tends to gain

whenever the market falls

(implying risk aversion),

and vice versa.

“This is probably [still] a

conundrum for many analysts,”

concedes Mr

Beecroft.


Foreign Exchange

Strategist adds risk­taking to his portfolio

PROFILE

STEPHENJEN

Jennifer Hughes

meets BlueGold

Capital’s man of

many parts

Every market watcher can

explain in detail his or her

best call.

Stephen Jen still remembers

vividly walking into

Morgan Stanley’s daily

meeting one morning in

February 2002 and calling

the beginning of the dollar’s

long-term downtrend.

The most heavily traded

and closely watched exchange

rate in the world is

the dollar against the euro.

Then, a euro was worth

about $0.87. Today, it is

worth about $1.47.

Since Mr Jen made his

call, the single currency has

appreciated by an average

10 per cent a year.

“The stars had been

aligned for a weaker dollar

for some time and all it

needed was a push from

something unexpected.

“It was the day President

[George W] Bush talked

about imposing steel tariffs.

I don’t know quite why I

was so definite and I

remember my boss looking

at me with some surprise,”

he explains.

Mr Jen was well known in

the markets by then as a

currency strategist for Morgan

Stanley, where he was

until May this year.

At that point he left to

join BlueGold Capital Management,

an oil-focused

macro hedge fund that

wanted more independent

macro analysis and to add

more active currency trading.

He was meant to begin

simply providing advice on

the fund’s currency exposure,

and to provide trade

ideas to the fund’s principals,

Dennis Crema and

Pierre Andurand.

However, on his second

day, he was given his own

StephenJen:FXhasnever

lostitslustre Charlie Bibby

funds to trade with. After

all those years predicting

what would happen, he now

has to back his convictions

with hard cash.

“I didn’t even really know

what to say to put on the

trade – I’ve learned a lot

very fast,” he admits. “I’ve

made some trading mistakes

for sure and I’ve learned

about managing my emotions

– and I never knew I

was emotional.”

Mr Jen never knew he

would be a currency strategist

either.

Born and raised in Taiwan,

he was studying electrical

engineering at the

University of California’s

Irvine campus when he

began taking a couple of

classes in sociology, history

and economics. At that

point he fell in love with the

latter and changed his

career direction.

“I liked engineering, but I

never found it that intellectually

interesting. But economics

I could love. I was

very liberal and idealistic,

and I wanted to save the

world,” he says.

This took him to MIT for a

PhD, where one of his professors

was Ben Bernanke,

now the chairman of the

Federal Reserve. His doctoral

supervisor was Paul

Krugman, now famous as a

columnist for the New York

Times and winner of this

year’s Nobel prize for Economics.

From there, he joined the

International Monetary

Fund, However, it was not

long before he gave up on

saving the world.

“I soon realised that the

world’s problems were more

political. We had the economic

resources,” he says.

In late 1996, he joined Morgan

Stanley’s Hong Kong

office, just in time for the

Asian crisis.

“It was just the best place

to be. The situation was so

challenging for everyone

that it was almost advantageous

to be someone new,

who could look at the variables

and think about FX

with no limitation on where

you thought the numbers

should be.”

Covering FX since has

never lost its attraction, he

says. In 1999, he moved to

London to cover the biggest

currencies – the so-called

G10, including the dollar,

euro, sterling and yen.

“It’s a mix of the market

and theory – and none of

the theories I’ve studied

work consistently. That’s

why its fascinating, because

it’s not enough to look at

the GDP of a country and

compare it with another.

“That’s too simplistic. You

have to think about capital

flows, monetary policy and

a whole range of other

uncertainties.”

Now, however, as part-

trader, part-strategist, he

has had to add in other

uncertainties – those caused

by the emotions of his trading

positions.

“Strategists have no real

sensitivity to price volatility

so there’s no emotion

involved,” says Mr Jen.

“Price action rarely complicated

my thinking then.

Now I’m thinking about

medium-term trends and

‘You have to fight

emotions with logic,

but sometimes

you are wrong’

taking risk on a daily basis.

“I’ve had to develop a

sense for knowing when to

double up, even when the

market is against you – and,

equally, to know when the

market is saying something

different from what I

thought and it means my

thesis is wrong.

“You can’t teach this, you

just have to learn.

“You have to fight emo-

tions with logic, but sometimes

you are wrong. If the

market is saying things you

hadn’t thought, then you

should listen.”

But if he can remember

his good calls, what about

his bad calls? “Oh, I can’t

remember them – I try to

block them out of my

mind,” he says, with a grin.

“But I guess some of my

clients might recall them.”


6 FINANCIALTIMESTUESDAYSEPTEMBER 29 2009


Banksandserviceprovidersprepareforreturnofhedgefunds

What is fast, trades around the clock and

across borders – and in huge size? It is of

course the FX market but the description

also fits hedge funds, which were the

fastest­growing power in the market before

the crisis.

Then, banks and other service providers

were queuing up to provide services to the

sector but in the last year, the funds have

pulled back for a variety of reasons.

Now those same banks and service

providers are readying for the return of the

funds and say the signs are there that the

recovery is beginning.

“Funds now have a handle on what they

have and can now go back into the market.

They didn’t pull back out of choice, it was

forced on them. Now interest in FX is picking

up again,” says Derek Samman, global head

of foreign exchange at the Chicago

Mercantile Exchange.

Hedge funds’ interest grew as the

technology improved; between 2004 and

2007, transactions between banks and other

non­bank financial institutions such as hedge

funds, more than doubled.

The funds were intrigued by the ability to

trade different strategies and ideas in a

genuinely round­the­clock market. It is these

qualities that participants believe are bringing

the hedge fund sector back to the currency

market.

“Throughout the crisis, FX demonstrated

how liquid a market it is. You can access the

market for hedging and for investment

purposes. You can invest to express macro

views, short­term views, you can play

correlations region by region,” says Frederic

Boillereau, global head of FX at HSBC, which

will shortly extend its prime brokerage

offering to cover FX.

Although Mr Boillereau does not believe

the funds will enjoy the same sort of easy

conditions and extreme leverage seen before

the crisis, he is confident the sector will

return in some force.

“This is a growing asset class – the range

of participants is wider than just hedge

funds,” he adds.

“People – even some hedge funds – used

to think FX was just part of the process of

investing overseas. Now they're saying: ‘Let’s

learn to use this properly’.”

The volatility seen during the crisis – which

pushed volumes to records but crushed

some funds – in fact helped pull the

survivors back in, bankers believe.

Foreign Exchange

Net brings power to the people

RETAILINVESTORS

Peter Garnham

explains how technology

opened the market to

surprising participants

If a financial market were to

be designed specifically for

the day trader, it might look

very much like foreign

exchange.

There are no lulls, no days spent

looking at a flat line on a screen

From Monday morning in New

Zealand, currency prices are

changing 24 hours a day, moving

continuously across the globe for

five days until trading shuts down

on Friday after the US close.

Once the preserve of the banks

and a closed shop of institutional

investors, technological advances

have opened the currency market

to the retail investor.

The internet has allowed individuals

access to greater liquidity

and tighter trading spreads while

more robust electronic deal

processing has made risk management

easier for both liquidity providers

and customers.

Indeed, the Bank for International

Settlements cited the rise of

the currency retail investor as one

of the main contributing factors

behind the 71 per cent rise in average

daily global foreign exchange

volumes to $3,200bn in the three

years to April 2007.

Although a comprehensive survey

of activity from the BIS is not

due out until next year, market

participants say retail trading volumes

are continuing on their

upward trajectory.

Indeed, dbFX, Deutsche Bank’s

online forex trading platform for

individuals and small institutions,

has seen volumes rise 37 per cent

in the year to August 2009.

Improving technology has

brought tighter pricing and electronic

deal processing to personal

computer screens across the globe.

But crucially, it has also disseminated

the information vital for

trading decisions.

“Trading strategies haven’t

advanced that much in 100 years,

but what has changed is that the

internet has provided a platform

Yenforday­trading:Japanesehousewivescanexertaconsiderableinfluenceonprices Reuters

for people to learn about the strategies

applied by professional traders,”

says Dary McGovern, managing

director at Timetotrade, the

portfolio management platform.

Now that technology has lifted

some of the mystique from currency

trading, he says, retail

investors are realising that trends

in the currency market are ideally

suited to the technical trading

strategies practised by a lot of

individual investors.

Mr McGovern says that in many

ways, currencies are easier to

trade than equities, given that the

FX market has greater liquidity

and there are rarely shocks that

move the markets between

expected macro-economic

announcements.

Furthermore, he says, currency

markets are more equitable than

other markets.

“The volumes involved in the

currency market make it very

hard to corner and macro-economic

information that influences

price movement is released to the

market in an open and fair way.

This is not always the case for

other investment types.”

Bankers say the extreme currency

moves provoked by the

financial crisis have also driven

volumes. “We’re seeing huge interest

and awareness in FX from

retail investors – either they’re

fearful of it – and don’t want exposure

to currency fluctuations in

their investment portfolio – or

they’re acutely aware they can

make money from FX products,”

says Ben Board at RBS.

Indeed, retail investors are

beginning to have an influence

over the direction of the wholesale

market, with Japanese investors

particularly active.

Yield-hungry Japanese investors

were significant forces in the global

carry trade that collapsed so

spectacularly in the wake of the

financial crisis last year. The

carry trade strategy, in which lowyielding

currencies are sold to

finance the purchase of riskier,

higher-yielding assets elsewhere,

made sense for them because of

the low interest rates available in

Japan.

But with the carry trade strategy

not now a prominent trend on

currency markets, retail FX activity

is showing little sign of slowing.

Indeed, Japanese retail investors

have an estimated $7bn of collateral

lodged at FX margin trading

companies, according to the

latest estimates.

This means that with leverage

of up to 40 times available on

those deposits, Mrs Watanabe,

the stereotypical Japanese

day-trading housewife, can exert

a considerable influence on prices.

“Retail volumes really are a

major driver of the yen,” says

Martin Wiedman, head of global

forex sales at Credit Suisse. “Ten

years ago it was unthinkable that

Japanese housewives could influence

the market.”

But retail FX activity is peaking

not just in Japan. Liquidity providers

report strong demand in

western Europe and in the US.

Betsy Waters, global head of

dbFX, says retail investing is

receiving an additional lift as individuals

adopt the high-frequency

automated trading systems pioneered

by hedge funds.

These computer programs,

which use complex algorithms to

produce automated trading signals,

can be bought and uploaded

over the internet by retail investors

and plugged into a trading

platform.

Indeed, dbFX reports that this

trend has exploded in popularity

since the start of the year. It says

currency trades generated by automated

systems have risen from

negligible at the start of the year

to represent about 20 per cent of

its customer flow in August.

Ms Waters says that some of the

buy and sell signals generated by

these programs now have more

influence on FX trading patterns,

especially at less liquid times of

day, and are dictating moves in

the wider market.

“Algorithms have reached the

retail market,” she says. “Some of

these systems are so popular that

they influence the institutional

market.”

Some observers expect this

hands-on approach from individual

investors to continue as they

re-assess their behaviour in the

wake of the financial crisis.

“There is an increasing awareness

among investors that ‘doing

it yourself’ is not complicated and

can reduce the costs of investment

management,” says Simon Denham,

chief financial officer at London

Capital Group.

“If there has been one definite

change over the last year it has

been the reduction in trust in the

historic managers of funds. People

have started to ask: ‘What is it

that these guys do to justify their

vast fees?’”

“Its very difficult to ignore the effect of FX

volatility on your portfolio. You can see FX as

a source of administrative problems, of

opportunity or a source of risk and it’s this

point that has now become abundantly clear

to everyone,” says Chris Hansen, head of

global macro services and clearing at

Deutsche Bank.

Paul Houston, head of FX prime services at

Credit Suisse, says hedge funds are now

reconsidering their choice of prime broker.

“The choice is no longer purely driven by

operational and cost considerations. Hedge

funds are placing greater emphasis upon

their prime broker’s credit standing and

balance sheet. This means there have been

clear winners and losers over the last year.”

Jennifer Hughes

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