Westpac examines the rise of the currency and the ensuing opportunities
There is no doubt that the currency markets are undergoing a significant shift with an increase in volumes and a larger portion of that flow being executed through electronic channels. Regulation is one of the key drivers, but the rise of China’s renminbi (RMB) and the acceptance of currency as an asset class are also shaking up the FX world. Westpac Institutional Bank, one of Australia’s largest banks, is well-positioned to leverage these new opportunities and meet its clients’ ever-changing needs thanks to its significant investments in electronic foreign exchange (e-FX) technology and post-trade systems such as Calypso.
One of the key requirements today is the flexibility of trading channels as clients now employ a wider range of sophisticated tools and platforms to access global liquidity. This ranges from the traditional voice to trading online. Across all products, global electronic trading volume accounted for 74% of the $5.3trn per day FX market in 2013, up from 71% the year before, according to consultancy Greenwich Associates’ latest report in 2014. This is a sharp contrast to the single-digit percentage figures in the early 2000s. However, the Bank for International Settlements’ (BIS) data shows that voice is still prevalent in the spot market which account for 35% of the global $2trn market volume. This market – where currencies directly change hands and traders take risks as market makers – is still largely being transacted over the phone.
The BIS’ latest triennial survey in 2013 also notes that overall activity is booming with daily volume in the global FX market rising by 66% from US$3trn in 2007 to over US$5.1trn in 2013, while daily volumes in Australia’s currency market rose by 35% between 2009 and 2012. London and New York continue to reign as the biggest FX trading centers but Asia is muscling in on their territory with Singapore now in third place, overtaking Tokyo which has slipped to fourth place.
The growing FX flow has been matched with a rise in electronic trading. According to figures from consultancy Celent, spot FX volumes climbed by 38% from 2010 to 2013 while swaps jumped by 27%. On the technology front, this translated into Westpac upgrading its operating systems in order to provide greater transparency to meet new regulations as well as improving straight-through processing but in a cost-effective manner.
The other fundamental development has been the increasingly dominating presence of the RMB on the global stage. Although it still has a long way to go before it topples the US dollar from its perch, the progress has been more rapid than many expected when the country first embarked on the liberalization road in 2009. The BIS ranks the RMB as the ninth largest FX currency in its recent survey, while SWIFT rates it as the second most used currency in trade finance – surpassing the euro in October 2013. Moreover, as of September 2014, it was the seventh most popular global payment currency, though the percentage was still small at 1.64% of total global payments. The volume of Chinese goods trade settled in RMB has also increased from virtually zero in early 2010 to 15% at the end of 2013 and it is anticipated that 30% of China’s international trade will be denominated in RMB by 2018.
The most important event for the RMB could take place this year when the International Monetary Fund (IMF) conduct its next twice-a-decade review of the basket of currencies its members can count toward their official reserves. There are reports that the IMF will include the RMB in this so-called Special Drawing Rights system alongside the US dollar and euro. If this is the case, it would allow the IMF to recognize the ascent of the world’s largest economy while aiding China’s attempts to diminish the dollar’s dominance in global trade and finance. China would need to satisfy the Washington-based lender’s economic benchmarks and gain support of most of the other 187 member countries, which many market participants believe it will.
The ramifications for Australia as well as New Zealand cannot be underestimated. The liquidity of the Antipodean currencies and their strong trading and economic links with Asia have already seen them increasingly being used as proxies for the region. This has resulted in the Australian dollar/US dollar being the fourth heaviest traded pair in currency markets while the New Zealand dollar/US dollar is the ninth most traded. The US dollar/Chinese yuan has surprised markets by coming from nowhere to number eight despite the yuan still being loosely pegged to the US dollar. Australia also stands to benefit significantly from the China-Australia Free Trade Agreement (ChFTA), which concluded with a Declaration of Intent signed on 17 November 2014. The deal, which has been ten years in the making, will strengthen already strong ties. China is Australia’s biggest trading partner, accounting for 20% of the country’s imports and 35% of its exports in 2013, according to data from the IMF. The Australian Department of Foreign Affairs and Trade estimates that the deal could add A$20bn to the A$150bn of the two-way trade that took place two years ago.
Part of the ChFTA also saw Sydney anointed as an official RMB hub. The sharp increase in the amount of Australia-China trade denominated in RMB that is forecast to take place will drive demand for specialized RMB financial services. China also announced that Australia will be granted an initial quota of 50bn yuan (AUD $8.2bn) under the RMB Qualified Foreign Institutional Investor program, which will allow Australian financial institutions to invest in China’s domestic bond and equity markets using RMB.
Westpac, which has become a foundational bank to the Sydney RMB hub, has also been busy strengthening its position by becoming one of the first foreign banks to set up a sub-branch in the Shanghai Free Trade Zone having secured approval from the China Banking Regulatory Commission (CBRC). The bank currently operates three branches in Beijing, Shanghai and Hong Kong and this landmark agreement will extend its service offering in the country across trade finance, structured commodity finance, debt capital markets, derivatives and FX.
In 2014, Westpac was one of only two Australian Banks to receive “market marker” licenses from the People’s Bank of China (PBOC), allowing direct interbank trading in both Australian dollar & New Zealand dollar/RMB.
The addition of an onshore general derivatives license is particularly key to the bank’s strategy to support the growth of the Australian dollar/Chinese RMB market which it believes is important in the internationalization of the Chinese currency. The license will enable the bank to offer G-7 interest rate linked derivative products followed by forex forwards and forex options on G-7 currencies. RMB linked interest rate and forex products will also be in the product mix once it has received approval for a bond license from the PBOC.
None of Westpac’s strategy could succeed without a strong and robust FX technological backbone. Three years ago, the bank decided to implement new systems in order to promote greater global consistency, increase straight through processing to reduce operational costs and meet new derivatives regulatory requirements. Other objectives included supporting FX volume growth as well as strengthening client relationships, replacing legacy systems and simplifying processes by having a single back-office system for all FX products and locations.
To this end, Westpac leveraged its relationship with Calypso, whose platform it had first implemented in 2006. The new end-to-end platform has not only provided global coverage for high-speed, high-volume and high-value trades in a cost-efficient operating environment, but it has standardized processes and business rules to meet the global tax, regulatory and compliance requirements. In addition, it has enabled multi-branding and the capability to distribute a broader product set to all Westpac’s financial market brands, while streamlining operating and IT processes by replacing a number of legacy systems.
The Calypso platform is also being used as one of the enablers in the bank’s push to cement and be one of the leaders in mainland China. The platform has allowed the bank to create a FX standard to meet the specific local requirements of the Beijing, Shanghai and Shanghai Free-Trade Zone. It has also enabled the bank to expand its derivatives and commodities trading as well as produce bilingual confirmations and reporting.
Being agile and flexible has always been a prerequisite in financial services, but this has never been truer than it is today. The FX market is undergoing significant change with increasing volumes and the prospect of the RMB joining the US dollar and euro at the currency reserve table. Regulation has also been a game-changer with different jurisdictions having their own versions of the rules. Without a strong technological foundation, Westpac would not be able to effectively meet the multitude of challenges and sharpen its competitive edge.