The $3.2 trillion average daily trading volume in the foreign exchange market towers above that of any other market. The fact that the currency market is both highly liquid and inefficient, with multiple providers of liquidity, makes it an attractive asset class for hedge funds and other traders who rely on computer models to take advantage of fleeting and small variations in prices.
The growth of electronic trading also has played a part in the emergence of foreign exchange as an asset class. Electronic systems have lowered the cost of trading, making it possible to successfully use strategies that depend on highfrequency moves in and out of the market. Meanwhile, best practices are evolving with the help of on-demand software that enables corporations to measure, analyze and control their currency exposure and avoid earnings surprises.
Technology, globalization and innovation have radically changed the nature of foreign exchange trading in the past few years. As investors moved into global markets in the 1980s in search of diversification and higher returns, they began to rely on currency overlay managers to handle their foreign exchange exposure. Now, more and more money managers and institutional investors are hedging amounts greater than the total exposure of their portfolios and are adding to FX positions in currencies that are appreciating in order to generate alpha, or excess returns.
Global custodians and other financial institutions with proprietary information on cross-border flows are discovering new ways to measure global investor sentiment and risk appetites. This is helping to provide insights into currency, equities and fixed-income securities in developed and emerging markets that can be used to generate alpha.
The Bank of New York Mellon has the world's largest custody holdings, with more than $20 trillion of assets serviced. This gives it a comprehensive view of flows across asset classes and geographic regions. The bank's iFlow product uses proprietary data from monitored custody assets to assist clients in formulating trading strategies. It provides historical charts, trading signals and statistics of simulated portfolio performance.
The iFlow equity indicators show that US-based equity investors have renewed their search for higher returns overseas and that Asia is the preferred destination, says Samarjit Shankar, Boston-based director of global strategy for the currency group at The Bank of New York Mellon. "Amid lingering risk aversion, any renewed search for yield will be more selective, rather than a headlong push into risky bets," he says. Currencies of countries that are running current-account surpluses will perform the best, since they are less vulnerable to the vagaries of portfolio flows, he explains. "As a result, we expect most Asian currencies to strengthen," he adds.
Barclays Bank, Citi, Deutsche Bank, JPMorgan, State Street Global Markets and UBS all have developed measures of risk appetite, as have the International Monetary Fund and the Bank for International Settlements. As of early October, State Street's cross-border equity flow indicators were at the "riot point," the most risk-averse of five investment regimes it maps, indicating broad-based retrenchment from equities, even as stock markets worldwide rebounded.
State Street's FX Connect is the leading institutional foreign exchange trading platform. Earlier this year, State Street acquired Currenex, a platform that focuses on the active-trading segment of the FX market. State Street has integrated Currenex with Global Link, its multi-asset-class trading platform.
State Street's foreign exchange flow indicator, FXFI, measures cross-border flows in currency forwards for 11 developed-market and 15 emerging-market currencies. The proprietary indicators are used in conjunction with other macroeconomic and fundamental currency indicators in making strategic forecasts.
Binky Chadha, strategist at Deutsche Bank in New York, says the bank's unconventional models for the euro against the dollar, focusing on bilateral flows between the United States and Europe and on emerging market reserve accumulation, both point to further gains for the euro. Deutsche Bank's longer-term flows model indicates that the dollar likely will decline against the Japanese yen as well.
Many corporations refrain from active management of their foreign exchange exposure either because they fear that currency hedging could expose them to speculative risks or because they simply don't know how to measure the exposure correctly. Other companies have created formal risk management policies to control FX risk.
"As the currency tides inevitably change, chief financial officers who have not yet established enforceable accounting and economic policies will be lost at sea," says Wolfgang Koester, CEO of Scottsdale, Arizona-based Fireapps. CFOs and treasurers need better predictability of how foreign exchange exposure will affect corporate performance, he says.
Fireapps 4.0, an on-demand risk management software platform issued in September, enables multinational corporations to predict, analyze and proactively manage currency exposures of a company's balance sheet and anticipated cash flows. This enables corporate financial officials to insulate their margins, revenues and the value of their firms from the impact of foreign exchange volatility, Koester says.
The ForecastFX module packages the cash-flow-related currency exposure management capabilities of Fireapps. Using ForecastFX, corporate foreign exchange managers use flexible templates to tailor the data they gather to create their cash-flow forecasts. This not only streamlines the process and makes the information available for use throughout the organization but also eliminates costly errors and omissions.
Corporate financial officers can model and analyze the impact of currency exposure over time, applying a "hedge factor" that reflects their degree of confidence in their forecasts. "ForecastFX helps companies to act on this analysis by making recommendations on appropriate future currency actions to mitigate the impact of foreign exchange volatility," according to Koester.
By introducing visibility into forecasted cash-flow exposures, the software empowers treasurers and CFOs to make optimal accounting and economic decisions that protect revenues and margins from unfavorable currency movements, while assuring compliance with industry regulations and corporate policy, Koester says. "Fireapps is turning the haphazard art of foreign exchange exposure management into a reliable, repeatable science," he says. As a result, multinationals are able to assert control over their financial statements and eliminate earnings surprises that result from foreign exchange exposures, he says. The enhancements ineluded in Fireapps 4.0 make it easier for companies to share data with existing enterprise resource planning, or ERP, systems and to drill down into the root causes of their exposure, he notes.
The mere existence of currency risk management policies within a company no longer satisfies best practices. The policies need to be reviewed periodically so they can be updated to reflect the current business and market environment, and they need to be adhered to at all times. With structured and disciplined data management, new analytical technologies and rules-based decision making, Koester says best practices in foreign exchange can be achieved. Whereas corporate financial officials previously looked at a snapshot of their currency exposure at a given historical point in time, they are now able to push a button and see their exposure in real time.
© 2007 Global Finance Media Inc. Provided by ProQuest LLC. All Rights Reserved.
Source: Global Finance
