Greater automation in emerging markets is widely seen to be merely a matter of time. Profit & Loss talks to Darryl Hooker, former co-head of EBS Brokertec Market and currently consultant at Capitolis about his experience in helping bring a larger ‘e’ focus to Russia and China.
Profit & Loss: Can you give us an insight into the thinking that saw you focus on first Russian markets and then China when you were at EBS? What are the main signals that identify a frontier market ready to move into the mainstream of EM?
Darryl Hooker: A common pitfall in emerging markets is to make the mistake of considering them collectively despite the fact that they have very particular and specific nuances.
Russia had been a commercial target for many years, but onboarding had been slow: even when dangling the bait of a worldrenowned spot G5 platform, traction had been hard to achieve. There were plenty of challenges – contract language, law, abundance of competitor choice, lack of historical product presence, lack of physical presence, and if that was not enough to dissuade us, the Russian ruble faced a massive obstacle for participants with regard to settlement risk.
This last issue was what indeed prevented the ruble from going truly “global”, but what led us to approach Russia in a unique manner. If we could lead efforts to improve the settlement of the ruble we could a) assist banks in preventing considerable settlement losses; b) grow the community of users globally; c) increase the actual traded volumes; d) establish our platform as the OTC leader in spot RUB; and e) expand our onshore community of users as a result.
In many respects, this was the tail wagging the dog in terms of a strategy, but the timing was right, and all of the objectives were achieved – our onshore client base grew tenfold in 18 months.
P&L: And China?
DH: We considered and approached China differently. The market in offshore renminbi was very cautious at inception, though everyone truly believed it would ultimately become a global market. Turnover was very subdued and the relationship the currency would have with its onshore counterpart was unclear. Market data was sparse, so we had to rely on client feedback to attempt to track and trend what was going on.
P&L: What do you think were the main factors in the growth we have witnessed in first Russian and then Chinese FX markets?
DH: There is a three-step rule that all currencies – and platforms – must follow in order to grow. Firstly, you establish a consistent price; secondly, you grow the community and that tightens the bidoffer spread; and thirdly, thanks to the first two steps being achieved, you build inventory. These steps are sequential and once achieved, provide a price with a competitive spread in a tradable amount, all supported by technology, access, knowledge and market data.
In both the Russian and Chinese markets we had to allay the perceived fears about the product that existed with end users, but once we had completed that three-step process we found we had created a habit and once a habit is established it becomes harder to break. It builds momentum unless it is driven in the other direction by regulation and/or politics, as we have witnessed from time to time.
Overall, the answer lies in scale. As a product grows it is much harder to ignore and customer interest and demand increases with it, making it commensurately much harder for market makers to stay out of the market.
P&L: Do better credit and risk models/technology mean that it will be easier for other markets to grow than was perhaps the case 15 years ago? How important is it to be CLS eligible for example?
DH: Technology is constantly improving credit and risk models, which will support an easier adoption of new/emerging markets once they have matured sufficiently.
CLS eligibility is a great enabler for growth currencies and is the holy grail for many in their efforts to be truly accepted, traded, or indeed included in reserves. Some institutions will not trade non-CLS currencies at all, which highlights its importance as a driver of growth.
P&L: What are the challenges in raising automation levels in EM?
DH: I don’t think there are any particular challenges in automating emerging markets in terms of the technology, there does have to be, however, a willingness to grow a currency and raise transparency levels on the part of the central bank or local regulator. Some central banks have concerns over their ability to control or influence their own currency as they attempt to embrace more efficient market mechanisms.
There also has to be a fiscal consideration for the actual cost of implementing these networks, but often the providers of these services, working with the local regulators, help to reduce and manage these initial outlays.
Raising levels of automation also sits well with the principles of the FX Global Code of Conduct for FX markets, as it generally provides greater audibility of the users of these markets – which cannot be a bad outcome.
P&L: In your experience, how receptive were local traders to electronic trading, and did this differ from your experience in the early days in G10?
DH: Local traders are often very excited about new systems and functionality and this is in part because we are working with a technologically literate generation, no matter where you are in the world.
When we first sought to transition voice trading to platforms there was some resistance in the face of inevitability. Of course, there were also strong early adopters from senior management, but the relationships and the bonds of trust between traders and voice brokers were longstanding and deep rooted.
The challenge was to create a new habit – to show traders how to manage the workflow between a broker and a machine. In some cases this took years, people and markets moved at very different speeds, but ultimately the transition was made and almost inevitably the bulk of that market became electronically traded. Looking at markets now, that process is much easier, the rate of acceptance and adoption is much quicker.
P&L: What is the key to getting buy-in from local traders and regulators? How important is it to be located onshore when building a market?
DH: To get agreement with the regulators and local participants is of course vital for a successful launch. Generally the local traders want new technology and platforms – often they have experienced them elsewhere – because they feel they are being brought up to speed with the wider world.
The regulators can at times feel technologically challenged in these growth markets and can find themselves taking a more naturally defensive or conservative stance, as they are less exposed to the commercial pressures of their local banks. This engagement can be an impediment to progress rather than an enabler.
When building a project onshore I think it is imperative to be based locally. The alternative is to commute back and forth, but this tends to lengthen the process and potentially can dilute the impact.
In Russia, a team of four relentlessly travelled back and forth to Moscow. We had to establish trust, then proffer education, next garner partnerships and support, and then finally get contracts signed and systems implemented. This required a huge amount of discipline and coordination, but substantial results were realised after just 18 months.
Our strategy for China required two of us to be based out of Hong Kong and use that as our Asian hub. We initially spent three months in Asia and this increased turnover tenfold – and a year later we had not only established our platform as the global leader, but had taken a market away from an incumbent – that hadn’t been done before.
P&L: Do you see further growth in the China story in particular? Can it become a major market in the sense of a G7 pair?
DH: I have every faith in the China growth story and the renminbi becoming a major currency. For several years I have referred to the CNH as a “major minor”. When news breaks in Beijing you feel the impact, the tremors, across all the global markets.
We often reflected on the size of the CNH market and what we felt was the inevitable move toward a single global currency, one that incorporated the CNY as well. We considered the CNH to be a canoe, growing into a small boat, then a large yacht and ultimately a mammoth oil tanker. Our ability to turn that market share around was in part due to the CNH perhaps being somewhere between a small boat and a yacht – once it reaches (and I don’t think it’s even close yet) oil tanker proportions, it will be even harder to move and ignore.
P&L: Away from trading technology, what else will help these markets grow?
DH: I am particularly excited by market innovations that bring greater efficiency. One challenge I have constantly come across in all markets, throughout my career in FX, is credit constraints – they have been omnipresent. I figure after almost four decades I should look to do something about this and I have been awarded a consultancy with a remarkable group in Capitolis, which is working on a new collaborative approach to capital markets solutions initially in FX and equities.
These innovative solutions will have a far-reaching and positive impact on all FX markets and participants, as well as make it easier for the next generation of developing markets.