Emerging Markets Survey Pinpoints FX & NDFs As Dominating Trading

LONDON--FX and non-deliverable forwards are the two most commonly traded products in the emerging markets, according to a survey released by Prebon Yamane at Forex '98 in Geneva. The study also found that average deal sizes are getting smaller, with 77 per cent of respondents saying transactions are typically under $5 million.

The study, Prebon's second annual survey, was conducted between December 1997 and January 1998, and was compiled from telephone interviews with 180 traders at a variety of commercial and investment banks across Latin America, Central Europe and Asia. Respondents were asked to provide details of their current trading activity by country, asset class and product, as well as the size and frequency of dealing. The study covers a range of financial products--including FX, equity, bond and interest rate trading.

A total of 39 per cent of respondents said they were involved in FX--the largest asset class in the survey. However, that figure was down slightly from the 43 per cent last year. Overall, spot and non-deliverable forwards (NDFs) were the two most commonly traded products, followed at a distance by government paper and cash equities. Currency options were the fifth most popular contract type traded.

The survey displayed considerable regional variation. In Latin America, interest in FX products grew from 31 per cent of trading activity last year to 43 per cent this year. The report claims that much of this increase is explained by growing popularity of forward FX transactions. NDFs were found to be the most commonly traded contracts, at 17 per cent, while interest in spot FX and currency options was lower than last year. But even within Latin America the picture was mixed.

Traders within Central Europe expressed differing sentiment as well. Although FX accounted for 42 per cent of trading by asset class, respondents noted much greater activity in Poland and Hungary, for example, than elsewhere. Polish NDFs were found to be the most popular currency product in the region, accounting for 20 per cent of activity, followed by Russian and Hungarian NDFs and Polish zloty spot contracts.

The survey puts the interest in NDFs down to a number of factors, including their advantage as an off-balance sheet instrument and a tool to deal with credit risk. The growing number of counterparties and the reduced amount of documentation and government red tape involved in trading NDFs are also factors enhancing their popularity.

Following the economic upheaval in the region last year, it is perhaps not surprising that Asian emerging markets registered the greatest change over the past year. The survey found that FX accounts for 39 per cent of volume traded in all asset classes, up from 31 per cent the previous year. Spot FX contracts are the most commonly traded FX products across most of the region, followed by NDFs and options.

Meanwhile, the dismal investor sentiment in Asia has been reflected by a nosedive in equities trading. The number of respondents who said they were involved in broking stocks and shares slipped dramatically in the region, from 41 per cent last year to just 6 per cent in the latest survey.

The turbulent economic atmosphere in emerging markets across the globe also made a clear impact on the patterns of trading. Extreme volatility has meant traders are dealing larger numbers of smaller deals. The 77 per cent of respondents who said ticket sizes are below $5 million contrast with 53 per cent last year. Meanwhile, just 1 per cent of deals are in the $11-20 million range, down from 12 per cent last year. Limiting single-party exposures was cited as the most likely reason for this change.

Another trend that contrasts with the results of last year's survey is the perception of risk. Convertibility risk is now seen as the key problem in emerging markets, displacing sovereign risk by a small margin. Turmoil in the currency markets caused many countries previously committed to freeing up their currencies, to slow down reforms in order to guard against speculative attacks, says Prebon.

Brazil, Russia, Mexico and China all top the list as areas of continuing interest to investors. Poland is also of significant interest due to its size and relative sophistication. Israel, Kenya and Zimbabwe were pinpointed as areas where investors are looking for future liquidity.

Looking ahead, 58 per cent of respondents expect trading activity in the emerging markets to increase this year, while 27 per cent expect it to remain stable and 15 per cent anticipate a decrease. The report notes that the enthusiastic 58 per cent is a surprisingly high number, given current economic conditions, but attributes the optimism to growing interest from the fund management industry.

In an effort to raise returns, fund managers have begun to include investments in emerging markets as part of their mainstream investment policies, says Prebon. This inflow of money should continue despite recent regional instability, and so long as it does, activity in these markets will increase.