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Liquidity: Emerging markets are the future
By Jennifer Hughes
Published: September 27 2010 17:38 | Last updated: September 27 2010
17:38
The Zambian kwacha is not a currency with which many people, even
foreign exchange experts, are familiar.

Barclays Capital, however, is doing its best to change this; the bank
now offers the currency through its electronic trading platform with
continuous prices available for trades up to $1m. Above that, clients
can request a price and the bank responds.

“That’s a quantum leap in accessibility,” says Michael Bagguley, head
of FX trading at the bank.

Emerging-market currencies are always the next big thing in FX, in
spite of their rollercoaster reputation – where “hot money” investors
pile in then scramble for the exits in a mass panic when the going
gets tough. The more famous examples include the Asian currency crises
of 1997 and 1998, and Brazil in 2002, when investor concerns over the
incoming government of Luiz Inácio Lula da Silva pushed the currency
from R2.283 to the dollar to R3.987.

But the argument goes that since then, given increasing trade
globalisation and gradual economic liberalisation, emerging-market FX
must be the next growth area.

Yet so far, the data show little of the so-called “EM” currencies
making great strides.

In September the Bank for International Settlements’ triennial survey
of the FX market did show a slight increase in trading volumes. But,
for the top 23 EM currencies combined, that amounted to them
collectively being involved in 14 per cent of currency trades, from
12.3 per cent in 2007. By contrast, the US dollar is involved in 85
per cent of all currency trades and the euro is in nearly 40 per cent
– up from 37 per cent when the BIS last surveyed the market.

There were successes for individual currencies within that, however.
Trading in the South Korean won, one of the biggest EM currencies,
rose by 25 per cent and activity in the Brazilian real jumped 75 per
cent in three years. Dealing in the Philippine and Chilean pesos, and
the Malaysian ringgit, all doubled.

Bankers say liquidity is definitely improving. “There are differences
in liquidity at different times for sure, but you get that with every
currency pair, including euro/dollar,” says Vincent Craignou, global
head of FX options at HSBC. “What you have now, that didn’t exist even
two or three years ago, is that I can get good prices in the
[Brazilian] real in Hong Kong or London – I don’t have to wait for São
Paulo to get in.”

Mr Craignou differentiates between the bigger EM currencies, such as
the won and the real, and the smaller, such as the kwacha.

Liquidity is also subject to the current markets theme. Recently, the
larger emerging markets have benefited from the widespread bet that
economic growth will be far better almost anywhere outside the
developed, western nations. Asian currencies have also gained from
gambles on the eventual revaluation of the renminbi and the
expectation that they will virtually match any rise in China’s currency.

“In EM, it tends to be on a story-by-story basis so it also depends on
whether there is a good story in that currency as to how liquid it
is,” says Kevin Rodgers, global head of FX derivatives at Deutsche Bank.

April and May this year are an example of this. The eurozone sovereign
debt crisis was reaching its peak, sending trading in the euro soaring
and overall currency trading to peaks that, by early May, outstripped
those in the data collected by the BIS in April.

Yet according to CLS Bank, the FX settlement system, there was no
corresponding spike in the volumes in the few emerging currencies it
deals with, such as the Mexican peso and the South African rand.

For the banks and for EBS, the interdealer platform that trades the
bulk of euro/dollar, the most popular currency pair, the general EM
“story” is worth backing.

“We’re seeing significant growth and we’re spending a lot of money and
resources pursuing these,” says David Rutter, chief executive of Icap
Electronic Broking, which runs EBS.

The underlying theory is a virtuous circle where rising global trade
and increased investment interest in emerging markets will benefit the
local economies. As these grow, their markets will liberalise –
including their exchange controls, of which China’s tight grip on the
renminbi is only one of the more extreme examples.

This in turn will boost trading volumes, which will increase
liquidity, attracting players such as high-frequency, algorithmic
traders (algos), adding liquidity.

“Once currencies freely float, you’ll see a lot of increase in
volume,” says Mr Rutter. “Algos play in the deepest, most liquid pools
and that’s not EM yet – but that will change.”