What is the main challenge when it comes to trading in emerging markets in Asia?
Of course, time difference is the first thing that comes to mind when you are a European or a US market participant. The second element is more related to the access to local markets, bonds, and equities, than FX itself. Even if local authorities have made strong efforts to develop their local markets, foreign investors still need to get the appropriate approval, not an easy task, for example, in China or India. Fortunately, exposure to FX markets is eased by the use of derivatives like non-deliverable forwards.
What might traders overlook?
Asian markets are different from other markets as they do not always react only to macro or technical factors. Authorities, especially in China, can influence the markets; they can’t reverse the trend but can limit the move.
A good understanding of the authorities’ willingness is necessary to trade these markets.
How can risks be mitigated when looking at trading in Asia specifically?
I would differentiate settlement risk from market risk. Settlement risk can be managed with a good knowledge of the counterparties, or the use of derivatives like NDFs to take exposure or to hedge, an instrument that limits the amount to be settled.
Market risk needs a proper calculation of risks in terms of statistics: VAR, stress tests etc. However, a very good knowledge of market positioning is required. The latter is certainly the most difficult to get as it needs in-depth experience of the market.
What is the outlook for future trading opportunities in East Asia?
Bright! Trading in East Asia can only grow in the future. First, because trading volume for most EM currencies is still well below the level of developed countries when compared in terms of ratio to GDP. Singapore and Hong Kong dollar are some exceptions as their trading volume is much larger than their associated GDP, but IDR, INR, KRW, MYR, PHP, THB and TWD have still a long way to go. CNY which is now ranked fifth in terms of trading volume and close to the median ratio trading volume/GDP, remains well behind JPY in terms of percentage of global trading – 7 % versus 17 % -. But it is three times more than ten years ago and is expected to grow much further.
Secondly, trading is becoming more and internationalised, meaning that more and more trades involve a counterparty outside the country that has issued the currency. East Asia is seeing more foreign investments. The middle class is growing, hence domestic savings, pension funds, local markets are deepening. This trend can only continue.
Why are traders increasingly looking to Asia as a means for diversification?
The first rationale is the attractiveness of continuously growing economies. GDP has increased considerably in Asia in recent years and is still expected to contribute to almost two-thirds of global growth in 2023. Economic liberalisation is going on in most countries: local markets are growing, getting better regulated and they are opening to foreign investments.
The second rationale is the orthodoxy of most central banks especially when compared to some of their LATAM or EMEA counterparts. Asian countries were able to appropriately reduce their external deficit since the financial crisis to successfully replenish their FX reserves and were among the first to hike interest rates to fight inflation in the last two years. All of this led to attractive carry (at least before the Fed hikes) with low volatility: exactly what investors are looking for!
The third rationale is, of course, the growing internationalisation of trade in these countries that can only lead to a surge in the weight of Asian currencies in central bank reserves. As an example, the Chinese Yuan now represents only 2.50 % of the allocated central bank reserves, a figure that can only grow.
Asian markets are getting more and more attention from investors. We at Ostrum Asset Management are so confident with this trend that we are strengthening our presence in Asia, while recruiting new credit analysts and fund managers. The objective is to manage Asian portfolios from Singapore but also to improve and develop our relationship with existing and new Asian clients.