Australian and Canadian banks are picking up foreign exchange business from their euro zone rivals as clients and market players worried by the bloc’s debt crisis seek trading partners with better credit ratings.
With anxiety rising about the chance of a major bank collapse, investors want reassurance that the party on the other side of their trade will still be around when the time comes to settle up – and are turning to credit ratings for guidance.
In contrast to many European banks saddled with the debt of troubled euro zone governments, the major Australian and Canadian banks have avoided some of the traps their peers fell into. Most, therefore, have stronger credit ratings.
This perceived lower risk is helping to attract new clients, such as pension funds, hedge funds and asset managers. While still mid-field players in the $5-trillion-a-day (U.S.) currency market, Australian and Canadian banks are steadily moving up the league table.
“People who wouldn’t have called the fire brigade if we were on fire are now calling us,” said a trader at a Canadian bank.
“We notice calls for us to become a liquidity provider rise in times of stress. It’s happened a few times over the past couple of years and is happening again at the moment, and is always related to crisis in Europe.”
The trader said that, if managed well, business could grow 15 to 20 per cent, although some calls came from counterparties who had themselves been downgraded and had credit lines cut.
Five or six major investment banks with sophisticated electronic trading platforms still dominate the foreign exchange industry, and there is little chance of Australian or Canadian banks usurping the top spots.
But as the debt crisis intensifies, those smaller banks have been taking business from euro zone institutions vulnerable to deteriorating market sentiment, traders said. The latest Bank of International Settlements report also said Australian banks have stepped in as European institutions cut international exposure.
A mass downgrade of many of the world’s biggest banks by ratings agency Moody’s last week intensified investors’ concerns. This means that sound banks could see even more business head their way.
Of 15 world banks cut by Moody’s, only one – Royal Bank of Canada – was Canadian, and none Australian. At Aa3, RBC is still rated above currency market leader Deutsche Bank, and big hitters Citigroup and Barclays, as are fellow Canadian institutions Bank of Montreal and Bank of Nova Scotia.
Some of the ratings resilience of Australian and Canadian banks can be traced back to their reluctance to deal in risky derivatives in the run-up to the global crisis. While the U.S. and a number of European governments had to stage bank rescues, no major Australian or Canadian institution has needed bailing out since Lehman Brothers collapsed in 2008.
The caution of the Australian and Canadian banks meant they struggled at first to penetrate the broader international market. This strategy, however, is paying dividends now.
“Banks who kept their noses clean are seeing an uptick in interest. Customers who may not have considered dealing with a niche player in the past are much more amenable,” said Graham Davidson, director of FX trading at National Australia Bank.
“At the margins it will boost revenues and, from a sales perspective, when talking to potential customers it gives you a little bit extra ammunition in doing your job.”
This year NAB rose to 39 from 48 in the annual Euromoney FX global market share survey, while fellow Australian Westpac jumped to 19 from 27.
Currency trading presents two main types of risk. One is settlement risk covering the period – typically two days – between one counterparty paying and the other receiving settlement for a spot transaction.
Settlement risk is also known as Herstatt risk and refers to the failure of a small German bank, Bankhaus Herstatt, in 1974 that resulted in a string of defaults for counterparties.
The other longer-term risk is that a counterparty may be unable to fulfill agreed transactions with a future value date.
In cautious financial markets, institutional investors such as pension funds are seeking to cut as much risk exposure as possible, while there may be a minimum counterparty rating specified in agreements between hedge funds and prime brokers.
“Credit ratings have a big input into their buying behaviour. Real money guys and asset managers have even higher requirements in terms of ratings. The composition of their bank panels is definitely changing,” said Hugh Killen, head of foreign exchange trading at Westpac.
Investors often keep a panel of banks which they use for currency trades. If a member bank suffers a cut in its credit rating, it may be removed from the panel and the investor then looks for a replacement – such as a Canadian or Australian bank.
Some euro zone banks are suffering badly from the state of their home economies. Spain formally requested up to €100-billion ($125-billion U.S.) in EU aid on Monday for its weakest banks, which have been brought to their knees by recession and a property market collapse. In addition, they have been heavy buyers of Spanish government debt, the value of which has dived.
By contrast, Australian and Canadian banks are benefiting from growing domestic economies which have been buoyed in recent years by strong prices for the commodities they produce, and also by demand to trade their more volatile currencies.
With volatility in the euro against the dollar, the world’s most traded currency pair, suppressed by expectations that both the U.S. Federal Reserve and the European Central Bank will ease monetary policy and the Swiss franc effectively pegged to the euro, traders must look elsewhere for wider price swings.
“The two commodities pairs of AUDUSD (Australian dollar/U.S. dollar) and USDCAD (U.S. dollar/Canadian dollar) provide a refreshing amount of volatility that helps traders participate in the market,” said Javier Paz, senior analyst at Boston-based markets consultancy Aite Group.
“Australian banks are well positioned to provide AUDUSD liquidity to an FX market starved for a currency medium to reflect the volatility taking place in the world today.”