Foreign exchange traders were faced with new challenges and opportunities last year. Warburg Dillon Read responded by structuring derivatives in new ways and integrating forex with other asset classes

This award was given not for market dominance and breadth of coverage – where Warburg Dillon Read (WDR) faces tough competition from rivals such as Citibank and Chase Manhattan – but for a flexible, imaginative approach to the changes sweeping the foreign exchange business.

As well as the obvious forex events, such as the creation of the euro, the dominant features of 1999 included a surge in mergers and acquisition activity, the rise of electronic trading and the Internet as a mode of delivery, and increased interest in outsourcing of foreign exchange by smaller banks using the facilities of larger, market-making institutions. Another important issue was the rollercoaster ride of gold prices. WDR was judged to have responded most imaginatively to the implications for foreign exchange trading of gold volatility.

Several other of WDR’s initiatives stand out: a structured deal for an Asian client with gold holdings; the promotion of foreign exchange as a separate asset class to private banking clients; the use of Internet technology in a cross-border merger; and the development of foreign exchange outsourcing services to smaller local banks.

A gold trade structured for an Asian institutional client was particularly interesting, given the volatility of the gold price in 1999 and the problems experienced by gold producers who overhedged when the price was low and suffered accordingly when it rose. The deal, believed to be the first of its kind, featured a linkage between a medium-term note (MTN) and a hedge fund index. The client held gold as an asset and did not want to sell or lend it out. When central banks began selling off gold and the price slumped, it was anxious to set a floor on the value of this asset. It also had a separate asset management programme that requires a high return on investments, but was restricted in how much exposure it could take to hedge funds. WDR put together a structure to protect the price of its gold assets for five years, while continuing to benefit from any upturn in gold prices – which have risen sharply since September, when European central banks announced strict limits on the sale of their gold reserves. The gold was swapped into dollars, at sub-Libor rates, then invested in a principal-protected MTN, whose return is indexed to the performance of a hedge fund basket.

The development of foreign exchange as a separate asset class to customers of UBS’ private banking group is also emphasised strongly by WDR. “We have been promoting forex as a separate asset class within our private bank and to retail customers. We have the largest private bank in the world, and a lot of our clients have a view on foreign exchange,” says Adam Kreysar, global head of foreign exchange derivatives at WDR in New York. “We structure this into an enhanced yield for them. These kinds of deals promote forex within the retail sector.”

This may seem rather less impressive in the light of the news in December that UBS has stopped publishing divisional profit targets – a move believed to be partly a result of the private banking business failing to live up to growth expectations. But Warburg has enjoyed success in offering structured currency products with a higher coupon than on money market investments, and says that its “hit ratio” in 1999 was well over 75% – in other words, clients got a yield pick-up in three out of every four such deals. Its “millennium issue” resetting strike warrant, for example, was a product aimed at clients who expected the dollar/Swiss franc exchange rate to be stable up until mid-December and then to bcome much more volatile. Using call and put warrants, WDR was able to structure a deal that could allow them to receive yield from this position. Resetting strike warrants are not particularly new in themselves, but WDR has done a lot of work on co-ordinating them across asset classes to create a suite of products, allowing private bank clients to choose across a range of such products in forex, interest rates and equity derivatives.

Mergers and acquisitions has been a valuable source of foreign exchange business for several banks in the past year. Companies involved in mergers or takeovers are increasingly stripping out the foreign exchange component of the deal, often going to a different adviser than the bank that is advising on the overall strategy or arranging finance. Warburg used the Internet in a corporate merger involving a European and a US company, setting up a special-purpose site to handle an active portfolio of some 40,000 forex and interest rate transactions worth several billion dollars. The other growth area this year has been outsourcing. Saint Gallische Kantonalbank, the public bank of the Swiss canton of Saint Gallen, is using WDR to transact its cash forex business. It does so using KeyFX, Warburg’s electronic order routing and dealing system.

Carrying out this range of business requires a robust, global risk management system. Kreysar points out that WDR’s system for spot forex has become truly global over the past 18 months, compared with many banks who have a spot desk in each location, each with its own position:
“We have one fully integrated global forex risk management system. As a result, the captured edge in any given deal has been enhanced, and there have been large savings in terms of netting flows. We have been doing this in options for years, but it is relatively new in terms of actual forex.”

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