When the crisis hit last autumn, interbank lines everywhere dried up like water in the desert and even soundly capitalised banks were struggling for funds. But the FX unit at SEB Group was still able to provide its clients – from manufacturers to private equity houses – with almost the same levels of liquidity as in the good times.
“Our rating and financial strength continued to give us large lines with other liquidity providers,” explains Joachim Alpen, head of the group’s FX team. “That meant we had more or less normal capacity to meet our clients’ liquidity needs. Also, we were able to warehouse risk on clients’ behalf. That took the pressure off them. We did that right through the crisis and we’re still doing it.”
A godsend to clients, that ability to deliver liquidity when it was most needed sprung from the group’s inherent soundness. Although many banks are still struggling, SEB group was able to post a 33 percent jump in profit for the second quarter of 2009 compared with the same period last year. Tier one capital stood at over 13 percent. As president and chief executive Annika Falkengren pointed out, “a robust balance sheet with a strong tier one capital ratio will enable us to support our customers and reinforce SEB’s market position in a difficult macro environment.”
And as a group with 400,000 corporate customers and institutions in Sweden, Germany and numerous Baltic countries, plus a local presence in other Nordic countries, Poland, Ukraine and Russia, SEB has a lot of FX clients.
Perhaps more importantly for its FX unit, the group’s reputation among its peers for meeting its own liquidity obligations stood it in good stead in their hour of need. “You can’t guarantee liquidity,” adds Alpen. “But SEB has a well-established network of inter-bank relationships and we were able to keep almost all of them throughout the crisis. The more solid your financial situation is, and the stronger are your long-term relationship, the better position you are in when the markets becomes unstable like it did in autumn.”
Not that it was an easy time for SEB Group or indeed other Nordic banks as the region’s currencies were hammered by the crisis. The two main currencies, the Swedish krona and Norwegian krone, inevitably suffered badly from the turbulence. The krona is vulnerable to the economy’s high dependence on exports while the Norwegian currency is hostage to the vagaries of the oil sector.
However the market as a whole coped remarkably well. The largest and most liquid trading product in the world, it has become increasing popular as a means of generating alpha-like returns because of the market’s deep liquidity boosted by 24-hour trading. Another feature is the broad – and growing – depth of participation. Increasingly, it numbers not only desk traders reacting to small but significant movements but longer-term investors seeking absolute returns, rather like value investors in the stock markets. As Alpen underlines: “It was one of the few markets that kept functioning more or less as usual, even if volatility increased and spreads widened.”
The FX domain is deepening all the time, in part because of the arrival of hedge funds and other alternative-banking institutions that are trading currencies more actively than before. Even long-established operators like SEB Group are having to tailor their offering to meet these developments. As more of its clients enter the market on their own account, treating FX as an asset class in its own right, the group has found that volumes are rising in proportion. In turn, that has triggered a demand for a different kind of research service and packaging of FX than was the case, say, five years ago.
One example of the rapid pace of development in FX is a form of protected trading for clients. Leveraging off its financial strength, the group is in a position to provide access to liquidity and credit to other parties, but in SEB’s own name. The group also takes on the full credit risk towards that client. Thus clients are able to tap into levels of liquidity at lower prices than they could hope to achieve on their own. Of course, the client pays for the privilege of using the group’s reputation.
The availability of products like these has been greatly facilitated by advances in the clearing infrastructure. As settlement processes become faster and more transparent, they reduce cost and increase liquidity, often described as the heart and soul of FX trading. “It’s a question of risk,” explains Alpen. “The smaller the settlement risk is perceived to be, the tighter the pricing can be. Also, volumes can also be larger.”
Contrary to popular belief, the FX market is unlikely to be dominated in the future by the global, behemoth banks. As an asset class whose efficient functioning is built on trust, the Nordic region like others is seeing the emergence – or, in some cases, re-emergence – of relative minnows. For Alpen, this is a healthy development. “In the short term, say the next two to three years, we are definitely seeing local and niche banks increasing in importance,” he enthuses. “It has become clear to all that you need a solid relationship with your counterparties. If not, you will be the first to go when lines reduce. This gives the local bank an edge.”
It’s possible the region’s FX market could be through the worst of the turbulence. As the global economy turns the corner, SEB Group’s expert believes the Nordic anchor currencies will strengthen. Although both still languish below their fundamentals, the krona has bounced back almost to pre-crisis levels. As for the krone, the FX markets expect the central bank to hike interest rates. At that point, predicts Alpen, expect a lot of profit-taking.
And of course it’s profits that will continue to fuel the region’s FX markets – and its liquidity.