Vigilance remains the watchword

The tumultuous market conditions are ensuring risk management remains the major consideration in all aspects of foreign exchange trading. Rumours about the health of a further two banks last Thursday demonstrated the need to remain vigilant with respect to credit and settlement risks.

In the article, 'A time for special FX' (pages 6-8), we look at how dealers have begun thinking more seriously and actively about ways to price in the counterparty credit risk inherent in foreign exchange deals with clients. Whether the entire market, including the smaller dealers, will be committed to gravitating towards this pricing convention is unclear, given the competitive nature of the business.

On page 11, we look at the risks to dealers when trading with each other more closely, and the strategic advantages that the current credit spread environment has for the stronger versus weaker banks. The article acts as a reminder of the hurdles facing the establishment of some form of FX central counterparty clearing facility. That's not to say that the concept should be ruled out, but that seeking out a common framework may be more difficult than initially perceived.

The question is how much more momentum is there in the continuing deterioration of the banking sector. It seems that the government bailouts of last year have failed to lift the mood this year, with last Thursday's S&P 500 price action on financials showing how vulnerable the sector is. On the plus side, governments were still willing to help with Bank of America securing a $20 billion capital boost as part of a $138 billion rescue package from the US government last Friday (Jan 16).

Meanwhile, and closer to home, traders are reporting that risk managers are maintaining a tight grip on position taking. Buy-side traders note that participation in the interdealer broker options market has demonstrated little recovery. "There might be 10 consistent market-makers in currency options currently, whereas a year-and-a-half ago you probably had about 30," one said. "Liquidity is not there and people's willingness to put out a quality price is not there in general. For a number of banks either the traders have shut themselves down, or the risk managers have told them to keep it really tight."

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