Features of Currency Swap Market

The secondary market is a highly opportunistic sub-sector of the currency swap market and, judging by Bankers Trust’s own activities in this market, the secondary market in currency swaps is relatively larger in comparison to the primary market. Some of the experts are of the view that this is due to a given swap counter-party having two chances to win on interest and exchange rates– in a currency swap and that with the enormous volatility of the dollar, a chance to win big on an exchange rate play. Although the original motivation may be to create a currency swap but the primary motive in the secondary market is to take profit before a currency move places the swap into an unprofitable position.

The secondary market phenomenon is an inherent part of the new breed of financial management which aggressively manages their cash flows and debt portfolios because they are judged by profits. The spreads tend to be relatively wider in the secondary currency than the secondary interest swap markets, move quickly when an exchange rate breaks is the key to the level of profitability. The exchange rate effects the profitability of a swap reversal is so much that the case of exchange rate that excellent prices and highly attractive rates can be obtained in the secondary market. The reverser needs to move quickly to capitalize on his exchange rate gain. This may lead to the virtual wholesale shutdowns of the primary market in currency swaps. This is so because of the fact that many counter-parties want to reverse at the same time. Consequently this will lead to substantial discounts in interest rates on the secondary market versus the primary market.

Unlike in primary market, the position-taking and market-making are very common in the secondary market due to the excellent pricing available in the secondary market, most of the times. Like the dollar market, sophisticated financial managers are aware that the credit risks are greater in currency swaps. When the time comes to reverse a position these sophisticated financial managers will make a market on the original transactions.

The Most Important Currencies of the Swap Market

The most important currencies in the swap market in rough order of magnitude are the Swiss Franc, Yen, Deutschmark, Pound sterling and Canadian dollar. These currencies are popular in the swap market due to their low interest rates (versus Dollar) and the relative ease of access by a wide range of issuers to private and public debt in the “Euro” and domestic markets of these currencies. Many supranational and sovereign borrowers find their access to the debt markets of such currencies constrained (versus their sometimes quite large requirements) and therefore make extremely active and frequent use of the currency swap market. Such entities either lend in their currencies (and are therefore covering/ matching assets with liabilities) or are trying to diversify their debt portfolios away from the dollar and the costs of the vagaries of that currency can impose on national budgets.

Even after so much development in the swap market, the domination of dollar continues. Though this is also the fact that many direct currency combination continues such as Yen/Swiss Franc. The other high interest rate currencies involved in the currency swap market are viewed as speculative vehicles for aggressive debt portfolio managers or companies in the local market which would have to pay dearly for fixed rate debt. This late comer accounts for the active use of exotic currency debt markets by prestigious international issuers. This has occurred recently in a number of capital markets in which the first few Euro issues are completed at wide divergence to the domestic market rates. Thus, the swaps which become available in this way, have accounted for the presence of many high—powered issues. The quality image gained by such issues, should on these markets has gained acceptance for new market and hence, fostered their growth.

Credit: International Finance Notes-MGU