Trading Led by Funds as Collusion Probes Roil Market: Currencies

Fund managers and electronic traders for the first time account for more than half the $5.3 trillion-a-day currency market as regulators investigate at least 11 dealers for alleged collusion on benchmark rates.

Hedge funds, pension managers, central banks and smaller lenders made up 67 percent of the increase in daily trading, from about $4 trillion in 2010, the Bank for International Settlements said in its quarterly review yesterday. Their share rose to 53 percent from 48 percent, while dealer banks, which buy and sell from clients, held steady with 39 percent.

Foreign exchange “has become less dealer-centric,” Andreas Schrimpf, an economist at the Basel, Switzerland-based BIS, and Dagfinn Rime, a senior researcher at Norway’s central bank, wrote in the report. The BIS was formed in 1930 and acts as a central bank for the world’s monetary authorities.

Regulators are investigating dealers from Goldman Sachs Group Inc. to Deutsche Bank AG, the biggest trader, for the manipulation of benchmark currency rates. At least seven banks have disclosed investigations and four more said they’re cooperating with the inquiries.

Prime Brokerage

At the same time, a decline in volatility is making it harder for traders and investors to make money, with Parker Global Strategies LLC’s Currency Manager Index down 11 percent from its highest point in 2010. The MSCI All Countries World Index of stocks has gained 33 percent since the start of that year, data compiled by Bloomberg show.

Non-dealer firms have boosted their share of the market as they got greater access to prime-brokerage services, such as electronic-trading platforms including ICAP Plc’s EBS, the BIS said. Electronic trading represented more than half the trades carried out by both dealers and non-dealers in April, the month covered by the report, the BIS said. Bloomberg LP, the parent company of Bloomberg News, operates a currency-trading platform.

“Hedge funds have record amounts of money under management at the moment and are a very sought-after client,” Neil Jones, the head of European hedge-fund sales at Mizuho Bank Ltd. in London, said in a Dec. 6 phone interview. “It does also add some diversity to a trading desk. Pensions funds have more money under management but tend to be a lot less agile.”

‘Distinct Market’

Dealer banks saw their share of foreign-exchange trading tumble from as high as 63 percent in the 1990s, according to the BIS report. Daily volumes across the market fell to $5 trillion in October from $5.3 trillion in April.

“There is no longer a distinct inter-dealer only market,” the analysts wrote in the BIS report. “A key driver has been the proliferation of prime brokerage allowing smaller banks, hedge funds and other players to participate more actively. Trading costs have continued to drop, thus attracting new participants and making more strategies profitable.”

The decline in volatility is hurting the profits of dealers that make money from exploiting the difference between the bid and offer prices they offer clients.

JPMorgan Chase & Co.’s Global FX Volatility Index fell to 8.41 percent on Dec. 6, from 11.77 percent on June 24 and 16.8 percent in May 2010. Implied one-month volatility for euro-dollar, the most commonly-traded currency pair, was at 6.56 percent at 9:19 a.m. in London, after closing at a six-year low of 6.19 percent on Dec. 6, data compiled by Bloomberg show.

Deutsche Bank said Oct. 29 that a “flat” market was “negatively affecting FX revenues.” HSBC Holdings Plc said Nov. 4 that revenue from foreign exchange fell 10 percent last quarter from a year earlier.

Withering Returns

FX Concepts LLC, founded by John Taylor, shut its investment-management business in October. In 2009, it was the largest currency hedge fund with $12 billion in assets.

The Parker Global Strategies gauge, which tracks returns of foreign-exchange strategies, fell to a 6 1/2-year low of 154.7 on Sept. 30, according to data compiled by Bloomberg.

Bloomberg News reported in June that traders pooled information about their positions with counterparts at other firms and tried to manipulate the benchmark WM/Reuters rates.

The rates are used by asset managers and index-tracker funds to determine what they pay for currencies and to compute the day-to-day value of their holdings, and by index providers such as FTSE Group and MSCI Inc. Firms have said they’re cooperating with authorities, and no one has been accused of wrongdoing.

Most of the increase in foreign-exchange trading from 2010 to 2013 has been related to higher-yielding assets as investors sought to boost returns, the BIS said. In the three years through April, the New Zealand dollar was the best performer among the 16 most-traded currencies tracked by Bloomberg against the U.S. dollar, strengthening 18.5 percent.

“With yields in advanced economies at record lows, investors increasingly diversified into riskier assets,” according to the report. “The climb in FX turnover between 2010 and 2013 appears to have been mostly a by-product of the increasing diversification of international asset portfolios rather than the rise in FX as an asset class.”