The credit crisis and rise of electronic trading have led to a fundamental shift in the global foreign exchange market towards risk mitigation over the last couple of years, according to research from CME Group.
The exchange, which partnered ClientKnowledge to survey 952 FX active organisations, found banks citing settlement risk as their biggest concern when supplying e-pricing, up to 69% from 52% last year. Worries about counterparty risk remain high, with two-thirds of those surveyed citing it as a concern in 2009. Concern about latency saw a 13% increase, up from 16% to 29%.
When assessing systemic risk, investors are more concerned by economic problems than banks. Back office and settlement limitations emerge as the biggest concern for banks, increasing to 47%, up more than twice the 16% cited in 2008. Worries about a liquidity crunch dropped significantly from 51% in 2008 to 33% in 2009, and credit or bank insolvency remains nearly unchanged at 26%.
Investors are more concerned about credit/bank insolvency in their view of exposure. Highly active investors' concern over credit/bank insolvency is at 44%, up from 36% in 2008. Liquidity concerns, the topmost worry in 2008, came in second at 36%. Worries regarding macro-economic problems jumped back up to 31%, from 14% in 2008.
In employing options, banks and investors placed more focus on plain vanilla options versus barrier and exotic options, suggesting that both banks and investors are making the move back to simplicity, liquidity and transparency, says the CME. Trading more complex options may be a more effective hedge now, but managing the risk over the life of the derivative still remains a major consideration.
David Poole, COO, ClientKnowledge, says: "The combination of the global credit crisis and development of e-trading has resulted in a greater focus on post-trade services, risk management and increased efficiency. FX market participants are balancing taking advantage of opportunities for increased revenue whilst accounting for market, settlement and systemic risk."
Meanwhile, separate research from Greenwich Associates shows that hedge fund managers are enacting a series of operational changes to reduce risk and enhance their ability to attract investors in the wake of the financial crisis.
The study examining the operational practices of over 50 hedge funds, commissioned by Omgeo, found that 70% of participating managers have altered their operations to reduce counterparty risk.
Almost 60% of managers have increased the number of prime brokers with whom they work - a move that virtually all say is intended to reduce counterparty risk. At the same time, nearly 40% have taken steps to enhance reporting and increase transparency for investors, and about one-third have started to obtain more independent valuations and accounting.
More than two-thirds of the hedge funds participating in the survey believe operational improvements and automation have a direct and positive impact on their ability to attract investors and assets.
Andrew McCollum, consultant, Greenwich Associates, says: "There's a real change of behaviour going on, the days in which investors would entrust their money to the black box of a skilled hedge fund manager are over. In the post-crisis marketplace, investors are demanding not only transparency, but also sophisticated operational processes and infrastructures capable of managing the types of risks they've experienced over the past 18 months."
You can read the full CME study here:Download the document now 445.2 kb (PDF File)