By Aaron Woolner, Editor of AsiaRisk
First published on 13 October, 2014
If the bout of volatility that hit the exchange rates of two of emerging Asia's largest economies in 2013 – India and Indonesia – was born in the USA, the short-term spike of volatility that hit both currencies in the second quarter of 2013 had its origins much closer to home.
Narendra Modi's election as India prime minister in May and Joko Widodo's ascent to the Indonesian presidency two months later were both presaged by an increase in currency volatility. According to Bloomberg, one-month implied rupee vol climbed 1.93 percentage points in April to 12.05, while the information provider says the same measure for rupiah rose to 11.65% four weeks before the poll in Jakarta.
But aside from these two areas – and excluding the unexpected reversal in the renminbi/dollar appreciation story in February this year – Asian markets, like their global peers, have been range-bound and characterised by low volatility. While the US Federal Reserve's impact on Asian foreign exchange rates may have been more muted than in 2013, the continued absence of a rate rise by the US central bank has dampened institutions' appetite for interest rate hedging, making the second half of 2013 and the first six months of 2014 tough for regional Asian banks.
So it's impressive that DBS's treasury and markets division, which houses all its derivative activities, increased its revenues by 5% as part of a broader positive performance by the firm that saw its first-half 2014 revenues exceed S$2 billion for the first time.
For Andrew Ng, head of treasury and markets at DBS in Singapore, these figures not only are positive against a backdrop of tough trading conditions but also compare very well on a compound annual growth rate (CAGR) against the global banks – particularly those whose fixed-income businesses have been hit hard by changes to regulation.
"For the last two or three years if you look at global banks, especially those which are focused on the FICC business, their CAGR growth is coming in at minus 11–15%. Whereas the CAGR for DBS treasury and markets business has been something in the region of 5–8% positive year on year. In this sense we have been outperforming compared with our global peers."
Ng says that the majority of this CAGR growth has been coming from sales, rather than the trading side of the business – meaning the "quality" of the bank's profits is also good. "Our trading is used to supporting our client business – I'm happy with the mix and strategy we have pursued for the last two to three years."
DBS has ambitions to expand beyond its core six markets of China, Singapore, Hong Kong, India, Indonesia and Taiwan and become a truly regional bank for its customers that have a footprint beyond the half dozen main business hubs. The firm has applied for a securities licence in South Korea and is considering whether to do so in Japan also.
DBS has been looking to complement its strong corporate franchise by building out its institutional investor business and is in the middle of setting up a London dealing room. Trading systems are being installed and will be operational by the end of October with the aim of having an active presence in the UK by the first quarter of 2015.
"We will have up to 10 people working in London and the aim is to provide a service across the global time zone so we can provide prices for Asian products 24 hours a day," he says.
Alongside a leading role in its home Singapore market, where the lender estimates it accounts for over one third of the USD/SGD interbank market with an average daily forex trading volume in excess of S$2 billion, DBS plays a key role in a number of markets around Asia.
In Hong Kong the bank's renminbi capability saw income from customer activities increase by 49% year on year over the past 12 months as appetite for the Chinese currency continued to grow, with a significant portion of this coming from new clients. Likewise it reported a 32% increase in its China income of 2013.
The use of target redemption forwards by corporates saw a number of firms – particularly those in Taiwan – suffer cashflow losses when the renminbi/dollar appreciation trend came to an abrupt halt in February this year, but Leung Tak Lap, head of advisory sales, Greater China and head of treasury and markets, Hong Kong at DBS, says the impact on the firm's client base was relatively slight.
According to Leung, its mainly manufacturing client base's flow of dollar receivable meant they had a natural hedge against dollar appreciation. Added to this DBS's risk managers had restricted it to offering products only when there was a genuine hedging need.
"It's hard to believe that renminbi can only go one way – so some time ago we talked to our risk managers and set a portfolio cap on how much we could do and decided that deals are done on a hedging basis. We did sell a few Tarfs, but this was to customers taking a view on the market and that was just a small percentage of our total portfolio.
"In any case when we sell these products we built in a significant cushion in terms of the strike in case CNH did appreciate. This allows end-users a lot of breathing space from a cashflow point of view – the negative carry for each client on a monthly basis was very small and the impact on our client portfolio was manageable."
As well as a strong renminbi franchise, DBS has an unrivalled access to local currency markets in South-east Asia, with a strategic advantage against not just locally domiciled players, says Kuwabara Daichi, chief treasurer for the Singapore branch of Sumitomo Mitsui Trust Bank (SMTB).
"When it comes to Singaporean products and accessing South-east Asian markets, DBS are not only much better than the other regional banks but also the large European and US players," says Daichi.
SMTB has a co-operation agreement with DBS in Indonesia to provide a broad range of services to Japanese corporates operating in the archipelago and it was in the South-east Asian state that the Singaporean bank made some interesting transactions ahead of the presidential elections.
One local corporate was looking to borrow a five-year dollar facility but with large local currency receivables it was exposed to a rupiah depreciation that could occur depending on the result of the looming elections. But with dollar/rupiah trading at a five-year high, the firm thought it unlikely that it would stay at the 12,000 rate for a prolonged period, thereby ruling out a long-term cross-currency swap.
In order to hedge the liability, DBS proposed a compound forex option, or what James Tan, executive director in treasury and markets international sales, calls an option-option.
"One of the challenges during an election period was that heightened pre-election volatility made the pricing of long-term hedges prohibitive to enter. So we structured solutions that provided effective hedging at an affordable cost. An example was the use of compound options which provided cheaper insurance than vanilla options but yet serves the purpose of protecting against a catastrophic move in the forex rate post-election.
"This is advantageous because you don't want to buy an option prior to the poll and then realise that postelection you could have bought it much cheaper."
Tan says that 50% of its corporate customers went down this compound route in the run-up to the election, primarily driven by a great level of uncertainty.
DBS's market capitalisation of $45 billion makes it the largest bank in South-east Asia and it has ambitions to expand further – previous attempts to expand its presence in the highly profitable Indonesian market with the purchase of Bank Danamon fell foul of Indonesian regulatory intransigence but in March this year it agreed the $220 million purchase of Societe Generale's Asian private banking business. This deal gave a mid-teen sized boost to the firm's assets under management but more importantly it also came with a distribution deal that provides access to the French bank's highly sophisticated product suite.
"One of our strategic priorities is to be a significant player in the wealth management sector," says Ng. "And the acquisition of Societe Generale's private banking business in Asia enables us to build on what is already a very solid platform, to further strengthen our competitive position in Asia."