Currency Trading – The Information One Must Know About
The intensive fluctuation of exchange rates since the early 1970s opened the way for derivative contracts in forex. Established exchanges were slow to grasp the opportunity and banks took the lead keeping the market at large off exchange floors. The same applies to spot forex, which has always been in the hands of banks. Although the market lacks an exact location on the local scale, it is heavily concentrated internationally, organizationally and currencywise. The top five banks handle almost one-half of all forex trading and most of the deals are made in a handful of global finance centres. The US dollar, euro and yen are the dominant currencies. The dollar is also an important reserve currency and has, in addition, replaced, either by law or in practice, the national currency in several financially weak countries.
If forex is the glue which holds international markets together, the texture must still be equipped with systems for payment and delivery. The speed of the actual transmission is hardly an issue, it is a matter of seconds or minutes. The problems are in administrative routines, incompatible legal systems and the differences in office hours between time zones, leading to settlement lags counted in days. Since many transactions are large, the ensuing exposures have prompted intense development towards more efficient and robust clearing and settlement systems.
The first question is about the location of trading desks. Since the activity is screen-based, one centre per central time zone should be sufficient. It is certainly desirable, because risks can be controlled better when they are centralized. Administrative scale economies are also possible. In practice, however, local regulations may enforce the maintenance of local units. The authorities wish to have the possibility of intervening, and that is much easier when the unit is within their jurisdiction. The centralization of trading differs from the origination of the business, which is best done close to customers. For example, in the mid-1990s, Citicorp had six the forex traders in two European centres, London and Frankfurt, against thirty-nine traders in seventeen centres eight years earlier. JP Morgan concentrated all its euro trading in London and closed desks in Paris, Milan and Madrid.
Creditworthiness is a key aspect in forex exchange market. There are banks routinely settling trades of $1bn and more, per day, with a single partner, and the exposure can last for days, because even spot trades need not settle earlier than the second business day. For such short maturities, the rating of commercial paper is the appropriate benchmark, and what it leaves in the air is covered by plain trust, reflected in the mutual credit lines which market participants grant to each other and which they enjoy from payment systems.
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