Hedge Funds and FX: Will the marriage last?
Godfried De VidtsPresident, ACI
Godfried De Vidts looks at the impact that the Hedge Fund industry
is having on the FX market.
Foreign Exchange trading that started as the first and prime tool
that created our banking industry has now grown up to an estimated
2 trillion US$ daily franchise. No other product equals this size.
Many of the senior traders in the markets have all started with
this simplest of product: you buy low and you sell high, or the
reverse. Are things that simple or do we need to look at other
factors? Are the flows between different currencies that should be
the basis for transfers from one currency to another still
dominating? Or is the proportion more like 10% for real business
flows and 90% speculation, or worse?
For those long enough in our business, prior to electronic trading,
the currency crisis of the ERM when the UK was humiliated is a good
reminder of strong forces in the currency markets that have
jeopardised many central bankers and careers of Ministers of
Finance. And what do we see today, huge movements in commodity
prices, the recent fall out in the Carbon credit area, the drop in
the Icelandic Krona value who is behind all this? Are we once again
loosing touch with reality?
Hedge funds you may say? After two dismal years the hedge fund
industry is booming, with growth between 4 to 8% and even retail
issues of 2 Billion US$ being marketed in order to increase the
availability of capital. The hedge fund industry is even involved
in mergers and acquisitions, big companies have come under attack,
board members have been forced to resign. And all this because the
masses of money under management have to be profitable so the
promised returns to the investors can be delivered and big
management fees can be paid to those in control.
So who is behind that incredible volume, and who is controlling it?
Are we heading for yet another disaster that the tax payer will
need to bail out?
The prime brokerage model certainly has allowed more non-banks to
participate. Never has the market seen more participants, both as
price takers and increasingly also as providers. The coming of age
of electronic trading systems has made this market transparent. The
changes are even being felt by individuals/ small investors who can
now play the game through preferred internet connections. And the
banking industry is willing to provide those facilities.
If all these people are making money, who is footing the bill? One
can hear that interbank platforms are losing money, one reason why
there is less proprietary trading in the dealing rooms of this
world. The interbank market is dominated by a few very large
players who are in close contact with the hedge fund industry.
The relationship between this client base and the very active banks
in foreign exchange is highly important. At the same time when
electronic trading is advocating transparency, understanding the
needs of your major clients and being able to read the flows has
become top game.
So can one order move the market? Certainly not in the major
markets like Euro, US$ and Yen. But smaller currencies can be under
threat when people similar to Soros see that the fundamentals will
support the trade. And if a number of large currency funds think
the same way, a little spark can ignite a firework. The large
imbalances of trade will be corrected. And while the hedge fund
industry is providing ample liquidity into the foreign exchange
market these flows will steer the government, the guardians on the
local currency into submission and redirection of economic policy.
One might say that hedge funds are becoming the gamekeepers. So
where are the poachers? Where does this leave the regulators and
central banks? Price stability and reflection of the true value of
a currency are important. Even more important is understanding what
drives the currency markets. By creating the possibility of an open
dialogue with the banks through the foreign exchange committees in
the major currency centres, officials at Central Banks try to
understand the markets. An open dialogue will quickly explain what
is the cause of sudden movements. Long gone are the days of open
intervention in the foreign exchange markets. In this trillion
dollar market no intervention on the foreign exchange markets alone
can be successful. But in carefully nurturing relations between the
policy markers, the politicians and the industry, this successful
business by the industry including the hedge funds could continue.
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