FOREIGN EXCHANGE

FINANCIAL TIMES SPECIAL REPORT | Tuesday September 27 2011

www.ft.com/foreignexchangesept2011 | twitter.com/ftreports

Currency trading soars amid stress

Global financial
volatility turns
investors to foreign
exchange, says
Peter Garnham

hen the going

gets
tough,
roughed-up
investors turn
foreign exchange

to the
markets.
As concerns have risen
regarding the worlds developed economies, volumes
on currency markets have
surged to fresh highs.

Investors have had much

to contend with over the
past few months. A downgrade of US government
debt, concerns over the
eurozone financial crisis
and currency intervention
from Japan and Switzerland
have all helped increase
volatility on world financial
markets.

Once again, currency

markets have acted as the
pressure valve for the global financial system.
Starting
on
Monday
morning in New Zealand,
foreign exchange markets
stay open 24 hours a day
until closing on Friday in
the US, giving investors an
opportunity to hedge their

exposure or take on fresh

macroeconomic bets.
The current situation,
although
not
yet
as
extreme, echoes the aftermath of the 2008 credit crisis, when the deep liquidity
in the worlds largest financial market gave investors a
lifeline as others seized up.
Sophia Drossos, senior

investor on the global

macro and asset-allocation
team at Morgan Stanley,
the US investment bank,
says the currency market is
an ideal place to express
macro views in times of
trouble, whether they are
directional or a hedge.
Continued on Page 3

FINANCIAL TIMES TUESDAY SEPTEMBER 27 2011

FINANCIAL TIMES TUESDAY SEPTEMBER 27 2011

Foreign Exchange

Foreign Exchange

Fear of Greek default

shakes euros stability

Inside this issue

Is the renminbi the next safe bet?

GO EAST Investors would love to get their

hands on more of the Chinese currency, but

limited access means it is unlikely to become
the global unit of choice soon Page 4

Silver lining for the dollar

RESERVE CURRENCY Despite poor

performance and a longterm downward

trend, no rivals have emerged to challenge
the US money units supremacy Page 4

Any port in a storm

SAFE HAVENS Traders are considering

alternative investments such as the

Norwegian krone and the Australian dollar,
but they are finding them wanting Page 6

It has been a good year for retail

STRONG GAINS This oncedisadvantaged

market looked set to suffer from new,

stricter regulation but it has fostered
growth in this sector instead Page 7

More on FT.com
Currency wars
Neil Dennis explores the
complicated fallout from
fluctuations in foreign
exhange
Living with franc
Swiss consumers are
adapting to a strong
currency but it is harder
for business, writes
Izabella Kaminska
Front Page Illustration

MEESON

Contributors
Peter Garnham
Currencies Correspondent
Jennifer Hughes
Lex Writer
Neil Dennis
Markets Reporter
Michael MacKenzie
US Markets
Correspondent
Josh Noble
Emerging Markets Editor
Izabella Kaminska
FT Alphaville Reporter
Martin Brice
Commissioning Editor

Jearelle Wolhuter
Liz Durno
Subeditors
Steven Bird
Designer
Andy Mears
Picture Editor
For advertising, contact:
Ceri Williams on:
+44 20 7873 6321
email:
Ceri.Williams@ft.com
Brendan Spain on:
+44 20 7872 3197
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Brendan.Spain@ft.com

Currency trading volumes soar amid global stress

Continued from Page 1

Monetary union
Peter Garnham
looks at the single
currencys future

he euro remains in
the spotlight as the
eurozone debt crisis
threatens to derail
the single currency, pushing some to question its
continued existence.
The euro remained resilient to the debt crisis over
the summer, trading in a
relatively narrow range of
$1.40-$1.45 against the dollar
since May.
But sentiment turned
against the single currency
as traders returned from
their summer breaks. Fears
over a possible debt default
in Athens and the resulting
effects on the eurozone
banking system had a negative influence.
Adding to the pressure
was a U-turn from the European Central Bank, which
abandoned its hawkish
monetary policy stance at
its September meeting, with
Jean-Claude Trichet, ECB
president,
warning
of
heightened downside risks
to the eurozone economy.
On September 12, the
euro dropped to a sevenmonth low of $1.3499
against the dollar and also
touched a 10-year trough
against the yen and a sixmonth low against the
pound.
The fall sparked a reaction that allowed it to
regain some poise, after
Germany and France reassured investors.
Angela
Merkel,
the
German chancellor, and
Nicolas Sarkozy, the French
president, put out a statement stressing they were
convinced that Greeces
future lay in the eurozone,
after a conference call with
George Papandreou, the
Greek prime minister.
This lessened fears that
the country would default
and raised hopes that
Athens would receive fresh
rescue funding from the
International
Monetary
Fund and its European
partners.
The euro received a further boost after central
banks joined forces to provide dollar liquidity, a move
that could ease funding
pressure
on
European
banks.
But not all observers view
the events so positively.
Neil Mellor, a currency
strategist at Bank of New
York Mellon, says there has
been a subtle shift in the

Nicolas Sarkozy and Angela Merkel are convinced Greeces future is in the eurozone

Franco-German approach to
Greece amid growing talk
of an inevitable default
by Athens.
He says the fact that Ms
Merkel and Mr Sarkozy said
they were convinced that
Greeces future lay in the
eurozone implied its membership was in question.
An ostensibly positive
statement about Greeces
place in the eurozone might
actually be seen as a stark
admission by its two largest
members that Greek membership cannot be guaranteed for the simple reason
that the EU cannot guarantee the country will not go
bust, says Mr Mellor.
However, Camilla Sutton,
chief currency strategist at
Scotia Capital, is of the
opinion that while low
growth in the eurozone, fiscal austerity measures and
worries over the banking
sector have raised concerns
about the future of European monetary union and
put pressure on the euro,
those fears should subside
in the longer term.
That is because the
framework of European
monetary
union
offers
limited options regarding
a
potential
break-up,
given that a country can

voluntarily negotiate to exit

the euro, but cannot be
expelled.
According to Ms Sutton, a
voluntary exit by either
Germany or Greece is
highly unlikely. For Germany, an exit is likely to
leave Berlin with a stronger
currency that could hurt
exports, while a departure
from Athens would only
exacerbate its debt problems. Ms Sutton says if
European policymakers can

There are limited

options regarding a
potential breakup
of European
monetary union
successfully deliver that
message, pressure on the
euro could ultimately ease.
These
fundamental
assumptions, if they can
be communicated, should
reduce the possibility of the
worst case scenario for
European monetary union,
she says.
Others remain less convinced, however.
Mansoor
Mohi-uddin,
managing
director
of

Getty

foreign exchange strategy

at UBS, the Swiss banking
group, says that even if the
structural
issues
over
Greece and European banks
were to be resolved, the single currency still faces
cyclical pressure as growth
in the region slows.
He says figures are likely
to show the impact of the
global slowdown hurting
manufacturing sentiment in
the eurozone, which is
likely to shift investor focus
on to the ECB policy meeting at the start of October.
That will be Mr Trichets
final policy meeting after
his eight year term as ECB
president.
He has the choice of cutting interest rates or leaving the decision to his successor, Mario Draghi, in
November, says Mr Mohiuddin. The risk of the ECB
starting to reduce interest
rates from 1.5 per cent is
that it would push the euro
lower.
The single currency is
likely to face a difficult
autumn. Of course, with no
other major central bank
looking close to tightening
monetary policy, the challenge for investors considering abandoning the euro is
where to put their money.

Its liquid, it trades

24 hours a day and you
dont get short-selling bans
in currency markets, she
says. They can be efficient
places to obtain tail-risk
protection.
Icap, the worlds largest
inter-dealer broker, reported that daily volumes hit a
record on August 4, and
continue to remain high.
But it is not just in times
of stress that investors turn
to the currency market. It
is, after all, the lifeblood of
international trade what
one senior banker refers to
as the internet of the global financial system.
Indeed, after a slowdown
in activity after the financial crisis of 2008, volumes
on the foreign exchange
market
bounced
back
strongly.
Although the fragmented
nature of the currency market makes collating data
difficult, the latest comprehensive survey from the
Bank for International Settlements, the central bankers central bank, showed
daily turnover in foreign
exchange
rose
from
$3,300bn in April 2007 to
$4,000bn in April 2010.
Much of this growth has
been put down to the rise of
algorithmic trading, as
improvements in technology have allowed investors
to use computer-driven
models more extensively to
trade on foreign exchange
markets.
Retail foreign exchange
volumes have also surged
higher, as improving technology has given individuals access not just to the
means with which to trade,
but also the information on
which to base their decisions.
While regulatory changes
have put a brake on some of
the growth, many see the
sector continuing to expand
in the years ahead.
Asian reserve managers
have also become increasingly important players in
this market, as attempts by
authorities in the region to
slow the appreciation of
their currencies against the
dollar has led to a large
rise in their foreign
exchange stockpiles.
Robin Poynder, head

of Europe, Middle East and

Africa treasury at Thomson
Reuters, says elevated interest in emerging-market currencies has driven growth,
as investors, faced with
near-zero interest rates in
developed economies have
looked for yield.
Among the currencies of
developed nations, the Australian dollar has also seen
growing interest, thanks to
its commodity-linked status
and relatively attractive
yields.
Mr Poynder remains confident that interest in
foreign
exchange
will
continue, despite the potential for a slowdown in the
developed
world,
as
trade in developing markets
expands.
The need for currencies
to fund real trade flows continues unabated. Trade is
still growing and the global
economy is still expanding, he says. Developing
markets
are
relatively
strong.
A notable bright spot has
been the development of the
offshore renminbi markets.
The speed of Chinas push
to internationalise its currency has taken many
observers by surprise.
Although trading volumes have been relatively
modest compared with the
rest of the market so far,
few dispute that the renminbi is set to develop into
one of the worlds significant reserve currencies.
Meanwhile, the industry
is expecting authorities to
retain their light touch
regulatory approach to the
cash foreign exchange market, even as derivatives
such as options and nondeliverable forwards are
moved on to exchanges.
The
spot
foreign
exchange market has, after
all, proved its resilience in
times of turmoil.
Banks remain optimistic
about further growth in the
sector. For most institutions, it is a core business
that delivers strong returns
on equity, but requires continued investment to keep
up with technological innovations.
We are extremely positive
about
foreign
exchange over the
next few years,
says Zar Amro-

Foreign
exchange
remains
a good
option for
brokers

Interest in foreign
exchange will
continue, as trade
in developing
markets expands

lia, global head of foreign

exchange at Deutsche Bank.
Competition will continue to intensify You have
to think about the strategic
changes that will drive the
business over the coming
years, he says.
Mr Amrolia continues:
Equally you have to
get your infrastructure
dealing in microseconds,
as
algorithmic
trading
increases. Its like running
a marathon but at the pace

of
Usain
Bolt
[the
sprinter].
Many expect the dominance of large banks to continue.
The importance of scale
has increased, says Mike
Bagguley, head of foreign
exchange at Barclays Capital, the investment bank.
He says the necessary
investment in information
technology and in offering a
full range of products
across emerging markets,

options, structured products and research is not for

the faint-hearted.
It is not the sort of business that you can take
lightly.
Foreign exchange came
through the financial crisis
with its reputation enhanced. Trade continues as
other markets buckle. Fears
over the global economy
could put it back in the
spotlight, but history suggests it will pass the test.

FINANCIAL TIMES TUESDAY SEPTEMBER 27 2011

FINANCIAL TIMES TUESDAY SEPTEMBER 27 2011

Foreign Exchange

Foreign Exchange

Chinese currency
could become the
next safe haven
Renminbi
Investors are
looking east but
access is a problem,
says Josh Noble

n the midst of the global currency wars,

China has stuck to its
guns. While speculative hopes of rapid gains in
the renminbi have dimmed,
Chinas policy of steady
appreciation remains intact,
prompting talk of a new
safe haven.
As use of the renminbi
spreads globally, it could
become a safe-haven currency, especially in a world
where the renminbi might
gain 2 or 3 per cent a year
against the dollar, while the
Swiss franc may yield nothing, says Patrick Law,
head of greater China trading at Barclays Capital in
Hong Kong.
Within Asia, the Singapore dollar and the Japanese yen have been the traditional risk-aversion currency plays. But, for those
who can access it, the renminbi could soon join them.
In recent months, weve

seen signs behind the

scenes that the renminbi is
becoming a safe haven,
says Mitul Kotecha, head of
foreign exchange strategy
at Crdit Agricole Corporate and Investment Bank
in Hong Kong. The crisis
may actually accelerate the
use of the renminbi globally.
In August, Chinese consumer price inflation fell for
the first time in months, following a period where the
authorities had briefly tol-

Hopes of rapid
gains have dimmed
but Chinas policy
of steady
appreciation
remains intact
erated stronger gains in the
renminbi. China has often
used the exchange rate as
one of its policy tools for
combating rising prices by
reducing
the
cost
of
imported food and fuel.
If inflation has decisively
peaked, then appreciation
may move down a gear,
though consensus points
to steady gains of between

3 and 5 per cent a year.

A greater worry for investors, however, would be an
end to appreciation altogether. In 2008, in the midst
of the global credit crunch,
China responded to economic uncertainty by halting the rise of the redback
instead resorting to a de
facto peg against the US
dollar.
With growing concerns of
a double-dip recession in
the US and Europe, could
China do the same thing
again?
In the worst-case recession, there is a risk of a
return to the peg. The
export sector still employs a
lot of people in China, says
Puay Yeong Goh, foreign
exchange
strategist
at
Credit Suisse, the banking
group.
However, most analysts,
including Mr Goh, believe
things are different this
time.
China is less inclined to
return to the peg were at
a point where it would be
seen as a big step back,
says Mr Kotecha. The
changing nature of Chinas
inflation problem could also
be a factor.
In 2008, inflation peaked
and then fell rapidly. Now,

The renminbi could turn into

a safehaven currency, if it
becomes more accessible
Bloomberg

inflation
will
remain
sticky, says Mr Law. Only
if China slows sharply will
the peg return, otherwise
the policy of steady appreciation will be maintained.
For now, the main barrier

preventing the renminbi

from achieving safe-haven
status is a lack of accessibility for global investors.
It has the potential to
be a safe haven, but that is
far from realised, says

Nicholas Kwan, head of

Asia research at Standard
Chartered Bank. In practical terms, there arent
many channels to get into
the renminbi, and liquidity
remains too low.

The question is how fast

the renminbi achieves full
convertibility. Will we still
need such a safe haven in
five years? I hope not.
In Hong Kong, where residents can purchase up to

Rmb20,000 ($3,134) a day,

the amount of the currency
on deposit in the citys
bank accounts has soared
in the past year, reaching
more
than
Rmb550bn,
or 10 per cent of the total

Lack of rivals leaves dollars reserve status unchallenged

US
The currency may
be weakened, but
it is not finished,
reports Michael
MacKenzie
The US dollar has been
steadily declining for more
than a decade. However,
given the lack of viable
rivals, its unique status as
the worlds reserve currency is not under immediate threat.
The dollar seems locked
into a secular downtrend
because of the dire longterm fiscal outlook for the
US and the fact that the
country continues to run a
hefty current-account deficit that is dependent on
funding from foreign investors.

The rising tide of longterm debt led Standard &

Poors, the rating agency, to
downgrade the US from its
triple-A status in early
August.
On
a
trade-weighted
basis, the dollar at its current value of 76.7, sits 35
per cent below its high of
120, set in July 2001. The
record low of 71.66 (in
March 2008) remains within
sight.
Helping keep the dollar
above its record low has
been the performance of the
euro, its principal rival in
the reserve-currency stakes.
The euro has come under
renewed pressure, as there
is no sign of the regions
sovereign-debt crisis being
resolved.
The euros problems are
so deep that, while reserve
managers can factor in that
the dollar will be around in
10 years' time, they cant be
sure about the composition

of the euro, says Alan

Ruskin, strategist at Deutsche Bank.
A big question for investors is whether the dollar
looms as a long-term downward bet. With nominal US
interest rates close to zero,
and likely to stay there for
at least two more years, the
dollar remains near record
lows against many rivals,
but has already registered a
large decline.
The dollars fundamentals have deteriorated substantially and the country
still has a sizeable currentaccount deficit in spite of
the slowing economy, says
Mr Ruskin.
He adds: One can make
the case that the dollar
could be seen as being overvalued, due to the current
account, but the three
words that counter that are:
Whats the alternative?
This year, the International
Monetary
Fund

released quarterly data on

the currency composition of
official foreign exchange
reserves. For the first quarter of 2011, it showed the
dollars share, excluding
China, has fallen to 60.7 per
cent for allocated reserves.
That was down from 61.8

The euro is no
longer considered
the natural
beneficiary of the
slow erosion of the
dollars status
per cent a year earlier, and
66.5 per cent in 2006.
Mr Ruskin says the 1 per
cent decline per year in the
currencys share of reserve
represents
a
glacial
change that continues to
paint a picture of reserve
managers struggling to find

places to hide beyond the

dollar.
But there is a risk that
the S&P downgrade may
compel reserve managers to
seek other currencies, such
as those from Australia,
Canada, Norway and Sweden, particularly as the
recent safe haven, the Swiss
franc, is now pegged to the
euro.
In our view, the US sovereign downgrade probably
brought about an acceleration in the pace of reserve
diversification out of the US
dollar and has helped sustain recent inflows into
emerging-market
fixedincome markets, as investors searched for new safe
havens, says David Woo,
strategist at Bank of America Merrill Lynch
The consensus, especially among long-term
investors, is that even with
the US dollar at decade
lows, it continues to face

serious headwinds, he
adds.
The
problem
facing
reserve managers is that no
other currencies can rival
the US in terms of size,
liquidity and stability. At a
time when the future of the
euro is being questioned,
the transformation of China
and Brazil into viable rivals
remains many years away.
There is a lack of alternatives to the dollar as a
reserve currency, says Dan
Katzive, foreign exchange
strategist at Credit Suisse,
the investment bank.
If you look around the
world, the euro has the
deep debt markets and legal
transparency, but not the
dollars institutional longevity. China is an emerging
reserve currency at some
point, but is very far from
having the legal transparency and institutional longevity that could rival the
dollar.

Mr Katzive said other

haven currencies, such as
the Canadian dollar and
sterling, lack the depth
and liquidity
of financial
markets
that
are
required to
back
a
reserve
currency.
The latest IMF
d a t a
show the
absolute
holdings of
euros as alloc a t e d
r e s e r v e s
dropped
to
9 9 5 b n
($1,361bn) in the
first quarter of
2011, down from
1,024bn.

Mr Ruskin says it is an
early
sign
that
the euro is no longer considered the natural beneficiary of the slow erosion of
the US dollars premier
reserve status, as reserve
managers instead seek refuge outside the traditional
group of four currencies
those of [US, EU, Brazil and
India].
Given the limitations of
smaller currencies, some
investors argue the time
has come for a more realistic appraisal of the market
and risk.
We are heading to a
world where everyone will
create a basket of currencies and people should forget about the idea that
there is a risk-free component in their portfolio,
says Axel Merk, president
of Merk Investments.

The dollar may not be as strong as it once was, but

it is still the reserve currency of choice
Epa

on deposit in Hong Kong.

But the investment opportunities remain scarce. Dim
sum bonds the name
given to renminbi-denominated debt issued offshore
in Hong Kong cover only
20 per cent of Chinese currency on deposit.
In 2010, there were just 17
dim sum bond issues, compared with 59 so far this
year, according to Dealogic,
the data provider.
Despite this rapid growth
in issuance, supply has
been unable to keep up
with demand. As a result,
such bonds are trading at

very rich levels, says Mr

Goh.
That could change if
inflation shows signs of falling. the Chinese authorities
have been wary of allowing
mainland companies to
raise funds at low interest
rates in Hong Kong and
repatriate
that
money
onshore.
For example, yields on a
recent dim sum bond issued
by Unilever, the consumer
goods group, was just 1.15
per cent.
But
in
August,
Li
Keqiang,
Chinas
vicepremier announced a quota

system to allow mainland

companies to raise up to
Rmb50bn in the dim sum
market.
It coincided with the third
renminbi-denominated bond
issue by the countrys ministry of finance, seen as a
vote of confidence in the
dim sum experiment.
As inflation slows, we
should see more dim sum
bond issuance, says Mr
Law.
We are likely to see bigger issues with longer
maturity, which will help
meet the demand for safehaven investments.

FINANCIAL TIMES TUESDAY SEPTEMBER 27 2011

FINANCIAL TIMES TUESDAY SEPTEMBER 27 2011

Foreign Exchange

Foreign Exchange

Investors
seek any
shelter in
a storm
Haven currencies
Market realises size
matters as it turns
back to US, writes
Jennifer Hughes

t did not take long.

As soon as traders
accepted the Swiss
were serious about
defending their currency,
they set about seeking new
havens.
Since the Swiss acted
with market-stunning force
on September 6, promising
to sell as many francs as
needed to ensure the euro
did not fall below SFr1.20,
the euro has jumped more
than 10 per cent.
So-called havens have two
attractions for currency
investors when markets are
as stormy as they have
been recently.
First, that they will offer
the shelter their name
implies. Second, and crucially, that they will entice
others to follow suit, producing a momentum-building trade that delivers profits for the early movers.
In the country hosting
the inflows, the effects can
be lethal for exporters and
the overall health of the
economy. The Swiss franc
had gained 20 per cent
against the euro, its most
important trading partner,
to its August 10 peak.
Early market efforts to
find new havens after the
Swiss move centred on
Scandinavia, namely Sweden and Norway. Watchers
cited the countries relatively strong fiscal positions
and their political distance
from the eurozone crisis.
In less than two days, the
Norwegian krone jumped
more than 2.5 per cent to its
strongest level in more than
eight years against the
euro, while its Swedish
counterpart added 2 per
cent for a three-month
peak.
However, it took only a
few more days before policymakers began emphasising the small size of their
markets and warning that
they too could take action
should inflows heat up.
Investors got the message.
Theres a huge focus on

risk right now, says Paul

Bednarczyk, a strategist at
4Cast, the consultancy.
If you want to run a
trade, youve got to explain
to risk and compliance that
you want to be long, say,
Norway. They start asking
you how big the market is,
then they Google Norway
news and theres the central bank governor warning
how small his market it and
how it could get messy.
The haven search is not
limited to European currencies. Ray Attrill, head of US
foreign exchange strategy
at BNP Paribas, the French
bank, believes the Australian dollar has good haven
potential.
You saw the money markets beginning to price in
Australian rate cuts months
ago, but the Aussie wasnt
reacting. Rate differentials
have tended to be a good
driver of the currency, so
we think it does owe something to safe-haven flows,
he says.
The Aussie has grown
rapidly to become the fifth
most-traded currency in the
world, according to the triennial survey of the market
conducted by the Bank for
International Settlements.
However, at 7.6 per cent
of daily turnover, it is the
leader of the second tier
rather than a member of
the top flight behind the
dollar (involved in 85 per
cent of all trades), the euro
(39 per cent), the Japanese
yen (19 per cent) and sterling (13 per cent).
The Norwegian krone and
its Swedish counterpart
rank 13th and ninth respectively, at just 1.3 per cent
and 2.2 per cent of daily
currency trading.
This leaves them vulnerable to sharp moves that currency watchers often liken
to cinema-goers who enter
the theatre in small groups,
but all try to rush out at
the same time. This was
evident last May when
Greece received its first
bail-out
and
Norways
krone swung wildly, falling
5 per cent in as many days.
That just isnt a real safe
haven, says Mr Attrill.
Other investors seem to
be coming to that conclusion and plumping for size.
The more liquid a market
is, the less it is likely to be

Oncedisadvantaged retail sector expands quickly

New regulations
Consolidation and
easier participation
drive growth, says
Izabella Kaminska

The carry trade has been dealt a blow by the volatility of the currency markets

Getty

Carry is dead Hopes for resurrection when market stabilises

Borrow low; invest high. The carry
trade the currency markets
leveraged version of the basic buy/sell
business maxim has been the
markets most popular and longrunning
trade idea, writes Jennifer Hughes.
In essence, carry trades are as
simple as that: borrow funds in a
currency with low interest rates and
invest the proceeds in currencies where
assets offer higher returns to collect
the carry between the two rates.
Popular with hedge funds and other
large institutional investors, the
principle has also been picked up by
retail investors, from Japans famed
Mrs Watanabe (the typical housewife
investor who showed a penchant for
selling yen in favour of Australian and
New Zealand dollars) to eastern
European homebuyers who, precrisis,
took out mortgages in Swiss francs to
get lower rates, but have since seen
their repayments rocket as the
currency has strengthened.
Popular funding currencies the
borrowing and selling leg of the trade
have usually included the Japanese yen,
the Swiss franc and the US dollar.
The exact size of the market is
unknown, but so popular has it been,
that estimates last year put its size in

The market has

tried lots of other
things but theyre
just not liquid
enough to be a
genuine haven

outstanding deals at more than

$1,000bn. This prompted regulators to
denounce it, most notably Adair Turner,
chairman of the UKs Financial Services
Authority. He described the trade as
of zero value and potentially
destabilising, and said the world would
be a better place if the size of trades
were reduced.
At the time just over a year ago
policymakers were increasingly worried
about the effect that the expected
normalisation of central banks interest
rate policies, including eventual interest
rate rises, might have on some of the
big macroeconomic bets placed by
investors, such as carry trades.
Lord Turner, who has launched
attacks against targets including
socially useless structured products
such as collateralised debt obligations,
need not have worried.
Carry has since been killed by
something powerful than regulators ire
market forces, particularly the near
universal low interest rates among
major currencies.
What isnt a cheap funding currency
these days? says Paul Bednarczyk,
strategist at 4Cast consultancy. Going
short the Aussie is not a carry trade,
but short everything else probably is.

rocked by the sort of

extreme moves investors
most fear. That has ruled
out the Japanese yen as a
haven, however, given the
governments record on
intervention to weaken its
currency and the yens current proximity to its alltime high.

Australian 10year bonds carry yields

of more than 4 per cent. Equivalent
10year Japanese government debt,
meanwhile, offers just under 1 per cent.
Last week, the US Federal Reserve
launched Operation Twist, selling short
dated bonds and buying longdated
ones in an effort to keep longterm
rates low. And the Bank of England has
been increasingly signalling it is
considering further quantitative easing.
What has really damped carry trade
investors ardour, however, is market
volatility. Carry bets, made with
borrowed money, only work in stable
market environments because sharp
movements decimate expected returns.
This, however, gives market watchers
the belief that the trades will return
when markets calm down once more.
Carry is dead for now, but itll
resurrect itself phoenixlike when
volatility dies down, because theres still
a tremendous search for anything
offering yield, says Ray Attrill, head of
US foreign exchange strategy at BNP
Paribas, the French bank.
At the moment were living in fear,
and thinking again about the return
of not the return on capital, but
Im confident carry will come back
when volatility dies down.

Most recently, the dollar

has been gaining rapidly,
particularly against former
emerging-market favourites
such as the South Korean
won and the Brazilian real,
suggesting investors are
retreating to the more liquid markets in search of
shelter.

The market has tried

lots of other things but
these places are just not
liquid enough to be a genuine haven, says Mr Bednarczyk. This means the
US is once again acting as a
haven, because everyone
knows there will always be
a market there.

It has been quite a year for

the retail foreign exchange
market.
In August 2010, the Commodity Futures Trading
Commission, the US regulator, announced a number of
new rulings pertaining to
foreign exchange providers,
among them a compulsory
minimum capital buffer of
$20m, as well as a clampdown on the leverage provided to customers.
While retail clients used
to be able to count on as
much as 200 to one leverage
from brokers, in the past
year they have had to get
used to ratios of no more
than 50 to one something
that has had an immediate
impact on the number of
transactions being processed by brokers. Capital
requirements, meanwhile,
have led to mass consolidation across the industry.
The foreign exchange
dealer category has become
the most heavily encumbered type of financial market firm today, from a regulatory perspective, says
Drew Niv, chief executive of
FXCM, the retail currency
trader. Thats why youve
seen a huge shrinkage in
the industry. There are now
dozens of names, instead of
hundreds.
Some well-known names
have disappeared from the
market altogether, while
weaker institutions have
had no choice but to be
absorbed into the remaining strong hands.
Its been a regulatory
earthquake, and in the next
year you will see more
aftershocks and more firms
going out of business, Mr
Niv predicts.
For those who were able
to ride out the storm, it has
not been so bad. Almost
immediately, they have
benefited from increased
market share, while the
temporary
sting
from
reduced customer flows is,
in the long run, expected to
deliver a much more stable
group of customers.
With reference to the regulations, overall, its definitely a positive for the
industry, and positive for
the customer, says Samantha Roady, founding partner of Gain Capital, the USbased company that runs
Forex.com, an online trading site.
In the beginning, customers were coming in and
relying on that leverage
and now youre seeing a
much
wider
customer
base, she says.

That means those clients

who are left are at least
likely to stick around for
longer.
The previous higherleverage model was detrimental to the customer, but
customers couldnt help
themselves. Churn didnt
occur because customers
were
disaffected,
but
because they went bankrupt, says Harpal Sandhu
founder of Integral, a foreign exchange technology
firm. The new rules shift
the market from a shortterm gambling model to a
longer term one.
Against the backdrop of
an increasingly volatile foreign exchange market in
an area where more volatility brings more opportunity
as well as low expected
returns from more conventional asset classes, most
brokers say they are confident the industry will continue to grow despite the
current regulatory blip. Foreign exchange, they point
out, is now an attractive
alternative to equities.
Retail foreign exchange
is now about 10 per cent of
the overall market, which is
pretty
amazing,
says
Gains Ms Roady. The
overall market is worth
about $4,000bn a day and
that will continue to grow.
Participants are now
more sophisticated and
knowledgeable than ever,
too.
Whereas retail was once
considered disadvantaged
compared with professional
trading firms or institutions
in terms of the service and
rates received from brokers,
this is no longer the case.
Not only are retail quotes
competitively priced, there
is little or no disadvantage
with respect to the wider
market.
It is a response to retail
demand for an ever more
equal footing, but it is also
because of the technological
tools which have become
available to the sector.
What made equities so
big with people, was you
had this democratisation
which gave [them] the same
resources as a professional
fund manager, says Mr
Niv at FXCM. Those tools
are now here in foreign
exchange.
Most retail platforms, for
example, support the means
to plug in automated trading packages available from
specialist vendors. These
can either be run as they
are or personalised. Either
way, the business for these
off-the-shelf algorithms is
booming, say market participants.
The tools available are
so empowering that the
market is full of institutional traders who have left
hedge funds and banks and
opened up shops of their
own, says Mr Sandhu of

What made equities so big

was democratisation.
Those tools are now here
in foreign exchange
Drew Niv,
Chief executive of FXCM

Integral. Weve been

hosting many of these
entrepreneurial
startups to help these guys
build their own systems
managing their own capital.
Large foreign-exchange
dealing banks such as
Citi, which have traditionally not marketed
themselves to the
retail sector,
have
been

quick to pick up on the

trend.
Just this month, we have
launched a product called
TradeStream, aimed at small
institutions such as brokers
and hedge funds, says Sanjay Madgavkar, head of margin foreign exchange trading
at Citi. Rather than go
through intermediaries, you
can deposit cash margin
with us and get exceptionally tight pricing.

FINANCIAL TIMES TUESDAY SEPTEMBER 27 2011