2016: A rollercoaster year for foreign exchange

Thursday, June 23: Britain made history by voting to leave the European Union after 43 years of membership and a bitterly fought referendum campaign.

The result – which came as a shock to many in the City – wiped value off the pound in a matter of hours. Sterling plunged against the dollar from a high of 1.49 on the day of the referendum to 1.36 the next day, before falling even further to around 1.26 today.

Sports Direct hit the news when it issued a profit warning and announced it could lose £35 million, due to a dodgy hedging strategy gone wrong. Travel company lowcostholidays went into administration, partly blaming the drop in the pound, and the cut in Bank of England (BoE) interest rates to 0.25% is making it even harder for banks to make money on lending.

The weak pound also has private equity firms that are investing in British businesses scratching their heads.

“It can have a huge impact on their return,” says Haakon Blakstad, director at Validus Risk Management, a financial risk management advisory service. “Private equity firms need to analyse how currencies impact businesses.”

Currency experts predict that businesses will face a ‘hedging cliff’ when their existing insurance against currency moves – such as forward contracts and options – expire. Companies typically buy protection for three, six or 12 months and lock in a set rate, but once that period is up they have to renew their protection. It is now more expensive to hedge, and companies face much poorer rates.

Every year, we see a blip in financial markets, which usually happens in stock markets. This year, it happened in currencies. On October 7, the pound plunged 6% against the dollar in just a few short minutes.

BoE governor Mark Carney instructed the Bank for International Settlements (BIS) to investigate; the fear amongst FX professionals is that this flash crash is the first of many.

Tod Van Name, Bloomberg

“[We have] witnessed some interesting market shocks the last year or two,” says Tod Van Name, ‎global head of FX and commodities electronic trading at Bloomberg. “The market is very resilient. It has just changed in the way it approaches risk and liquidity provision. [It’s] not as generous in where and how it shows prices.” Structural changes are sucking liquidity out of currency markets – shorter periods of higher volatility are causing big, discrete gaps in the market and poorer pricing, bankers told Euromoney earlier this year.

It is more expensive to make markets in FX, say bankers, due to the rising cost of credit, compliance, technological investment and legal costs, among other factors.

“You find many firms assessing how they participate in markets and the cost in terms of capital – financial and human,” says Van Name.

FX trading is shrinking for the first time in 15 years, according to the BIS’s triennial survey, published earlier this year. Global daily average volumes in spot FX were down by a fifth in April, compared with the same month three years ago.

The FX industry had been largely left untouched by regulators, but the benchmark-rigging scandal broke in 2013 and shone a spotlight on the inner workings of the world’s largest financial market. Billions of dollars of fines later, the industry set about instigating change and fixing its shattered reputation.

This year, the BIS’s Foreign Exchange Working Group (FXWG) published the first half of a new global code of conduct, with input from leading FX players from the buy and sell side.

In November, Guy Debelle, chair of the FXWG, announced that firms will need to “take practical steps such as training their staff and putting in appropriate policies and procedures”. He also suggested those that sign up to the code should shout about it from the rooftops to encourage their peers to stick to it as well.

Banks pay heed to Debelle’s words of wisdom – in February 2015, he fired a warning shot at banks to clean up their FX businesses or expect an increased likelihood of a regulatory response. Banks quickly responded – changes included separating information flow and offering clearer options for customers that want to trade currencies at the benchmark fix.

The second half of the code – expected in May 2017 – is expected to tackle issues including the controversial practice of ‘last look’, whereby banks can pull a price from a platform, even when a customer has clicked on it to trade. The imbalance of power has attracted huge criticism from certain voices in the industry.

However, despite the progress made in creating new standards, the past continued to haunt the industry in 2016. Fired traders, including Carly McWilliams and Robert Hoodless, successfully sued Citibank for unfair dismissal over the currency benchmark scandal, spurring on other dismissed traders to have their day in court.

Furthermore, Mark Johnson, HSBC’s former head of FX cash trading, was arrested by the US Federal Bureau of Investigation earlier this year and charged with wire fraud and conspiracy charges over a multi-billion dollar currency deal. Stuart Scott, HSBC’s former head of FX cash trading for Europe, the Middle East and Africa, faces the same charges.

Both have pleaded not guilty. If found guilty, they face up to 30 years in jail.

In October, the Chinese currency became the first emerging market (EM) currency to be included in the IMF’s special drawing rights basket, a basket of reserve currencies. The RMB is now the most popular EM currency to be traded, according to the latest BIS survey published earlier this year, having overtaken the Mexican peso.

However, the steady devaluation of the currency has irked the soon-to-be new US president Donald Trump, who regularly on Twitter accuses China’s of manipulating its currency.

But the yuan faces strong external pressures, such as the strengthening dollar and more interest-rate hikes from the US Federal Reserve, all of which make further devaluation more likely. The Chinese government has implemented new capital controls, to try to stem the outflow of money from worried businesses and individuals in China.