Forwards "Dry Up" In Punt And Peseta As Exchange Controls Strangle Market


The reimposition of exchange controls last week in the Spanish peseta and the Irish punt has completely dried up the forwards market in the two currencies, say traders in London. The controls, imposed to stem speculative selling of the peseta and the punt in the wake of the EMS crisis of the last weeks, essentially return the two markets to their status before the gradual deregulation of the past few years.

Although the controls are expected to be lifted soon--and must be lifted by the end of the year according to EC single market regulations--some question whether the punt and the peseta will soon regain their previous volume and liquidity.


In the case of the punt, says John Beggs, chief economist of Allied Irish Banks in Dublin, it is not so much that new controls have been added as the existing regulations tightened. Although Irish exchange controls have been largely dismantled recently, "there are some left," he says. One of these has been a requirement that all forward transactions have a genuine commercial purpose, he says. Up until now, the Irish commercial banks have been left to administer the regulation for the central bank--which Beggs insists they have scrupulously done--but now the Bank of Ireland says the paperwork must go directly to it.

Other existing exchange controls have also been "important in seeing off speculators," says Beggs, including a rule prohibiting Irish banks from short term lending to non-residents. Although Beggs claims that the tightening has not really changed the situation, nonetheless he admits there is little interbank trading in swaps right now. "It's illiquid with very wide spreads, because of all the uncertainty," he says, describing the spot and other markets as also "very difficult."

Traders in London, however, say the tightening has made a difference. "The Irish market certainly has dried up," says one National Westminster Bank trader. "Controls are always restrictive to foreign exchange business, and certainly in Ireland that is the case." The NatWest trader says that in the past, Irish banks simply "wanted to know if there was a commercial background to the transaction, and sometimes they didn't even ask." Now, with the tightening, he says, "they want documentation every time," effectively choking off trading, except for companies who have a strong need for cover.


The situation in Spain is perhaps more dramatic, although traders in London say peseta forward prices are still available at enormous spreads. Exchange controls have been progressively abolished over the past two years, leaving an essentially free market in Spain, which has seen increasing liquidity and volume in the peseta as investors poured money into the country. All this has now come to a screeching halt, say traders, as the market waits anxiously for the government to lift the controls again.

"Market liquidity has dried up in peseta swaps," says Shelley Mau, treasurer of Banco Santander in London, "except for banks pricing very protectively." Corporate clients are finding it difficult to find cover, she says. Banks outside Spain are finding it impossible to deal in swaps with Spanish banks because the controls limit the banks to the size of the positions they held on September 22. If they want to do additional amounts with non-residents, they must deposit an equivalent sum interest-free with the central bank, according to sources at Spanish banks in London.

Naturally, says Steven MacGuire, treasurer of Credit Lyonnais in London, "the peseta swaps market died a quick death." A swaps trader at Banco Bilbao Vizcaya (BBV) in London explains that corporate clients who need cover can sell pesetas to the bank, but if they want to buy them, the bank must have another position to close out before it can do the transaction.

Interbank offers in swaps are out there, he says, but at very wide spreads. The situation is slightly better now than it was right after the controls were put on, when it was difficult to find offers at all, says the BBV trader. He adds that a Europeseta market does exist, but that the rates are much more expensive than in the domestic peseta market.

Credit Lyonnais' MacGuire says he expects "a two-tier market, like we used to have," to reemerge in the peseta. So far, the bank, which ran an extensive book in the peseta before the crisis, has not had difficulty meeting its customers' needs, he says, because it still has plenty of liquidity in the currency. The bank decided to stock up, as it were, on some of the weaker currencies in the EMS when the crisis struck, he explains.

Permanent Effect?

Assuming controls come off soon, what will happen to the two markets? Some suggest they will be a while in climbing back. "The majority of players aren't messing around in those currencies right now, it isn't worth it," says MacGuire. "They're putting resources into other things." Uncertainty, some suggest, may prevent banks from coming back even when the markets return to normal. Others are more sanguine. "Everyone is afraid of the peseta now," says the BBV trader," but I don't think confidence will be harmed in the long run."

As soon as the Banco d'Espana lifts the controls, the market will return to normal "little by little," he says. "It will be okay in one or two months." Meanwhile, Spanish bankers wait with bated breath for the central bank's next move. "There is a rumor that the Banco d'Espana will lift the controls next week...." says the BBV trader wistfully.

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