It is political dissidents and rioters that most often fall foul of Indonesia’s anti-subversion law. But following heavy selling of the rupiah last month, fund managers could face the ultimate penalty under the same legislation.
After the run on the currency that forced it to float free of its US dollar peg, Indonesian justice minister Oetojo Oesman warned that currency speculators could face subversion charges. “If this practice adversely affects the country’s economy, it can be categorized as a subversive offence,” he said. He stressed that the anti-subversion law is still valid. The maximum penalty is death.
Indonesia’s government is not the only one in the region to react emotionally to “speculators” – the new public enemy. The Thai government has threatened to set the local mafia on George Soros, mastermind of the Tiger and Quantum hedge funds, should he make the mistake of spending even one night in Bangkok. Soros has also been named by Mahathir Mohamad, the prime minister of Malaysia, who accuses him of trying to impoverish already poor countries.
That may be one result of Soros’s activities, but it can hardly be his motive. Bankers in Asia argue that hedge funds are rational investors who trade on fundamentals; their sole motive is profit. But Soros is a convenient and well-known target.
This view of Soros is reminiscent of the old Soviet propaganda posters depicting top-hatted Uncle Sam figures with fat cigars and dollar signs in their eyes exploiting the socialist workers of the world using whips, chains and the power of the greenback.
The focus on Soros and other US-based investors appears to be an attempt to divert attention from powerful locals who politicians and central banks dare not attack in public. A number of Chinese billionaires, who have typically built their wealth on commodity trading, are a significant and highly leveraged force in the foreign-exchange market, bankers say, although the volume they control does not yet equal that of the US hedge funds.
“Just look at how many financial institutions here in Hong Kong offer private banking – that says it all,” says a foreign banker. Another Hong Kong banker reports that several wealthy customers were asking for credit lines on Friday, August 15, presumably to buy dollars and profit from the market pressure on the Hong Kong dollar. Malaysia and Indonesia are home to a smaller number of billionaire speculators.
An old quip of bankers – “If you buy, you’re an investor, if you sell you’re a speculator” – is being retold by Asian financiers, who find it an apt way to describe the official view of the currency crisis. “The central banks seem to believe that if you do the natural thing and hedge or go short, you’re a speculator,” says one banker. “If you’re an investor, everyone loves you.”
Market participants admit they are worried – most of the bankers and investors who spoke to Euromoney declined to be named.
All this has led bankers to question whether Asian central banks can distinguish between speculation and legitimate investment strategies. Thailand’s relative economic weakness, for example, no longer justified the baht’s pegged level before it was forced to float. “The market looks for inconsistencies between a policy regime and the fundamentals. In Hong Kong, the dollar peg twinned with the free-floating rate against the yen implies there’s something to be tested. Do you call it speculation or market-efficient behaviour?” says the head of a Hong Kong investment house. “Is this a market or a kindergarten?” asks another banker, more bluntly.
Some bankers refuse to use the term “speculator”, which has become loaded and politicized. They insist that investors should be judged only according to their knowledge of the market, their professional skill at analyzing trends and the size of their leveraged portfolios.
There were sound economic reasons for the attacks. But the central banks did not respond entirely rationally. “They’re in a difficult position,” says Chris Pavlou, Midland Bank treasurer in Tokyo and Asia-Pacific delegate on the executive committee of the ACI, the forex traders’ association. “If they defend something that is not sustainable they’re going to throw good money after bad. An adjustment was needed, and they might have devalued 5% to 10%. But because of their insecurity, the central bankers sat there hoping for the best. And the market did it [devalued] for them.”
Arguably the pressure on Asian currencies – with the exception of the Thai baht – was not generated by speculative attacks by foreign investors at all. They were one influence in a complex world, say some bankers, who are convinced the myth of conspiratorial speculators was created and nurtured by central bankers to win public support for the local currency. The central banks will not comment.
After all, it was quite clear that the real danger to the Hong Kong dollar was not from speculators but from a possible loss of public confidence in the local currency and a capital flight into US dollars. A triumphant announcement by the Hong Kong Monetary Authority (HKMA) on Monday, August 18, that it had “defeated the speculators” was disregarded by bankers; one shrugged and described the statement as “words for public consumption”.
The alternative view of a widespread loss of confidence suggests that the currency turmoil was triggered not by speculators but by local companies – and by banks.
Until the currency crisis this summer, domestic corporations in Thailand, Malaysia, Indonesia and other Asian countries routinely failed to hedge their forex exposures because they believed the US dollar pegs were inviolate. When the local currencies were cut loose from those pegs, companies grew frantic and started buying US dollars and other major currencies as quickly as possible. Local currencies were sold in substantial volumes.
The central banks realized that banks were not only executing trades for the so-called speculators but also giving them credit lines. Rather than trying to mitigate the damage to their economies, central banks immediately devoted their attention to finding out which banks had financed speculators – and trying to punish them.
Although some banks are too wary to admit to giving lines to the hedge funds – which are believed to be leveraged 20 times over – others admit it’s business they covet. Hedge funds are considered to be particularly well informed, as well as powerful enough to move the markets, so banks are keen to deal for them and offer them credit lines. Banks able to follow the market movements of hugely leveraged investors can earn handsome returns – and many did so during the currency crisis of recent weeks.
So many banks are clamouring to lend to the hedge funds that the funds can state their own terms. For the banks, the commission they earn from hedge funds direct is just the icing on the cake; the market information they glean is much more valuable. “I don’t have to be a clever trader if I have hedge funds as clients,” says a European bank treasurer in Hong Kong.
Typically, banks in Asia finance hedge funds for around $10 million to $20 million on each transaction, so a large number of banks are needed to raise the billions some hedge funds have been placing in the market in recent weeks.
Cosying up to the funds
But since client information is more valuable than trading commission, banks are keen to be as close to the hedge fund as possible – lending via other banks is not favoured, despite the risk that central banks will discover their identity. There would be no advantage in lending money at one remove, says a foreign banker in Hong Kong. If the business is there, he wants to deal directly with the investor and win the business – and the market intelligence that comes with it – from competitors.
If banks’ trading rooms do imitate the movements of the hedge funds, that augments the market-moving power of every hedge-fund decision to buy or sell, and makes the banks just as dangerous to the stability of a currency as the “speculators” they follow.
Some central banks claim to have precise information about who does what. Last December the HKMA installed a sophisticated real-time gross settlement (RTGS) system, specifically to enable it to identify trades and counterparties on the same day.
Bankers say this system is not as foolproof as the HKMA claims. Euromoney was told how banks re-route currency trades through a chain of trusted friends at banks located in other financial centres – New York, London and Tokyo appear to be the main ones, probably because almost all the banks have branches there. “It doesn’t matter where you execute as long as you get the trade done,” says one treasurer. It is a simple and effective method of avoiding detection by the monetary authorities, since even the Hong Kong RTGS system will reveal only the name of a Hong Kong-based bank’s immediate counterparty, not others further down the chain.
Even banks that deny direct links with the hedge funds are well aware of the part they play in the system. “The investment banks hedge their positions out with US commercial banks, which in turn refinance with us,” says Stuart Gulliver, treasurer of HongkongBank.
Central banks appear less concerned about banks’ other activities, some of which are in a moral grey area, as the banks themselves admit. By focusing their attention on George Soros and his alleged agents, the central banks are ignoring the fact that many banks are celebrating the currency crisis as a rare opportunity to earn huge sums on their forex and equity trading desks.
By trading all the currencies affected – except the Hong Kong dollar – banks with sufficient trading capacity earned handsomely off the wider bid-offer spread in August’s volatile money market. HongkongBank is one market-maker that has invested substantially in trading capacity throughout Asia over the past couple of years. That investment has now paid off, says Gulliver. “This is when you establish yourself as capable of standing up in the markets. This is when you seal your competitive edge.”
With hindsight, many bankers now claim that they placed appropriate hedges on Asian currencies months ago. They believed that the Thai crisis was inevitable, as was the knock-on effect on Malaysia, Indonesia, Hong Kong and now Korea.
This may be idle boasting after the event, but it may be true. If banks not only took early adverse bets on Asia’s currency pegs, but also passed on that intelligence to the hedge funds, their valued customers, that makes the banks the precipitators of the currency crisis, because they started hedging first.
One prominent Asian banker said that to his knowledge Soros did nothing in the mid-August fortnight when the most significant attacks on the Hong Kong dollar occurred. It is certainly true that banks trading on their own account add substantial volume to the market.
Banks also profited from the link in market sentiment between the Hong Kong dollar and the Hang Seng stock index, which is regarded as a perfect hedge on the local currency. Some banks’ proprietary trading desks sold the Hang Seng short in July and early August before they began selling Hong Kong dollars, thus benefiting from the inevitable fall in the Hang Seng when the currency came under pressure.
Even those banks without first-hand intelligence from hedge funds or other smart operators were apparently speculating on their own account, according to their competitors. Dominant local banks tend to accuse “US and European banks” of this activity. Not all were successful: some US and European banks lost substantially because they were short in the baht and other Asian currencies when overnight rates were pushed up to starve out speculators.
How much of this is legitimate activity? The central banks clearly haven’t decided. Thailand is about the only country which has operated a systematic policy of trying to curb speculation, and it clearly targets investors, not banks, as the culprits.
The Bank of Thailand tried to persuade domestic banks not to provide baht to speculators. That merely resulted in a chaotic two-tier currency system with different rates onshore and offshore. The resulting devaluation was inevitable (see separate article), and the Bank of Thailand has stopped short of trying to punish banks.
Pavlou of the ACI reports that Asian central banks have sometimes asked individual banks not to carry out speculative trades on their own account, and believes the banks complied with that request. “After all, these are not rich countries, and the central banks don’t have the experience of the Bank of England or the Bundesbank. You have to support them.”
The cold shoulder
There seems to have been pressure on a few banks – the big, establishment institutions in each Asian financial centre – not to deal with specific investors. These banks complied – to an extent. They say they did not refuse business outright but rather gave demand the cold shoulder by quoting defensively, or by stating that lines could not be renewed immediately. “It’s like paying taxes,” says a Hong Kong treasurer. “You have to comply if you want to do business [with the central banks].” But he says the sacrifice of that business does the bank little harm: local money trading is a small-margin business anyway in usual circumstances and may even be a loss-leader for other business.
By contrast, foreign banks, particularly branches of US and European banks with modest local trading operations, insist they would not turn down business at the request of a central bank or monetary authority, and say they have not been asked to do so anyhow. They don’t have much to lose, and money trading is a significant part of their business.
In countries where the gross settlement system is not as sophisticated as in Hong Kong, central banks routinely ask banks about their volumes and the identities of their -counterparties. In Malaysia, heads of banks have been summoned to the central bank (Bank Negara) to explain the pressures on the currencies and the fundamentals of supply and demand.
The most effective ploy from Joseph Yam, head of the HKMA, was to allow overnight rates to rise from the usual 6% to around 20% at one stage, making it prohibitively expensive for investors to run short positions. Similar tactics were used in other Asian countries.
Bankers reason, however, that if the central banks had had sufficient data they would have acted much more decisively against individual institutions. The HKMA, for instance, threatened to raise rates selectively for particular institutions, but has not yet done so. Instead, it has resorted to rhetoric and a few strong-arm tactics.
Yam began to boast about the size of Hong Kong’s reserves – at US$70 billion the third-largest in the world – and even persuaded the People’s Republic of China (PRC) to pledge its US$50 billion reserves to defend the Hong Kong dollar. Bankers either smiled or were irritated by the HKMA’s tactics, regarding its boast as an amateur taunt.
Thanks to the interbank system, the volume of money in the forex system is vast, far outweighing the reserves of any central bank in the region, including the HKMA. “Only 3% to 4% of the daily forex turnover worldwide is underlying,” says an Asian banker. “These people [the central banks] have no idea what they’re up against.”
Demonizing the traders
The central banks’ failure to communicate with banks and investors has not encouraged a spirit of cooperation from banks and investors. Malaysia’s prime minister Mahathir, for example, challenged Soros to a public debate, then withdrew the invitation. Some say this was because he was afraid his less-than-expert grasp of international markets would be exposed. Bank Negara – now under new management – declined to speak to Euromoney, saying that the situation was too volatile for any public statements at present. Meanwhile, the HKMA has said everything via the media, simultaneously “demonizing the currency traders”, as one bank treasurer puts it.
In theory, central banks have substantial leverage over intermediaries. Threatening banks’ asset management business is one means of soliciting loyalty. Foreign banks in Hong Kong – market sources say this involved either two or five US investment banks – were threatened with the loss of their mandates for managing HKMA reserves because they were suspected of trading on behalf of speculators.
Certain other penalties can be meted out to commercial banks, such as the the threat to withdraw a banking licence or the denial of refinancing. Hong Kong banks were even refused refinancing by the HKMA during the week ending August 15, with the authority refusing to explain why. But central banks don’t want to risk driving bankers away to rival financial centres: the monetary authorities in Hong Kong and Singapore are particularly sensitive about this.
Legislation to force banks to reveal details of their counterparties in money-market transactions is possible, but no country is likely to introduce it because of the risk that banks will decamp to rival financial centres.
For banks, corporate finance mandates are always worth protecting. The HKMA has managed to create the impression that a misdemeanour in Hong Kong will now have direct consequences on corporate finance business from the PRC government. Whether true or not, this has its desired effect if bankers believe it. Some told Euromoney that they would turn down trading business if they thought they would be penalized on the corporate-finance side.
Furthermore, the HKMA has threatened to punish any banks it finds were acting on behalf of speculators in the week ending August 15, when the attacks on the Hong Kong dollar were at their height. But this sort of approach has so far mainly remained a threat. No central bank except Thailand’s has taken action. Although the story about the HKMA’s mandate threat is well known in Hong Kong, none of the bankers Euromoney spoke to knew which banks had been warned. This suggests the story may have been a myth created by the HKMA to shake banks up.
In view of their past activities, central banks also lack credibility as guardians of the moral high ground. In the late 1980s and early 1990s, for example, Malaysia’s Bank Negara was the biggest speculator in the market, using its own reserves to place huge bets on international currencies. “Negara was one of the arch-speculators for years so their stance now is pretty ironic,” says a Hong Kong banker.
Bankers remember now with amusement how the huge position-taking of the Malaysian central bank, involving enormous speculative bids on other currencies, rocked the markets, terrifying other participants. In fact, banks’ experience of Negara as a speculator taught them that if there are highly active speculators around, it’s best to be on their side and to know what they’re doing.
Big against small
There is sympathy from some bankers for the small currencies ruthlessly attacked by the hedge funds, even though bankers foresaw and anticipated the crisis of confidence, particularly in the Thai baht. “The game’s not fair, big against small,” says one treasurer.
It seems to be up to the individual bank to decide how far to go, independent of the central banks’ strictures, and in accordance with their own standards of fair play as well as their own interests. It’s in the big banks’ interest to protect local financial systems. In Hong Kong, for example, they have substantial involvement in all aspects of business, including commercial property. “If the banking system implodes we make less money. No earnings in the trading room can ever compensate for the loss of the annuity stream from our general banking business,” says HongkongBank’s Gulliver. But foreign banks with modest trading rooms in Hong Kong and massive lending power from their headquarters in other countries have less to lose.
What central banks can do is work together more closely. Cooperation between Asia’s central banks is still limited, although the ACI’s Pavlou believes this will increase. “The currency crisis has taught them what to do. This has been the only time they have had to share information,” he says.
Pavlou believes that the central banks are beginning to work together well enough to share information about currency trades routed through a chain of counterparties to conceal the original executor, although they might have to rely on market participants to help. “The confidentiality of the market is not so great that [this information] wouldn’t leak out,” he says.
Some limited cooperation between central banks has already begun: after the Mexican peso crisis in 1995 the HKMA initiated a repo facility between the Asian central banks known as the liquidity adjustment facility. No information has been issued about whether it has been used to date.
Technically, the way to acquire information would be for each country to install an RTGS system and share the information they receive on the same day. So if speculation occurred, they could act in concert to freeze certain participants out of the market, and could even simultaneously raise short-term rates.
Some commentators, such as Norbert Walter, chief economist of the Deutsche Bank group, insist that Asian central bankers will have to agree to correct their “chronic lack of leadership” by listening to those among them who are more authoritative and experienced. The trouble is that forcing ideas and authority on other nations is not the Asian way.
Japan seems to be stepping out of the shadows. Eisuke Sakakibara, vice-minister of finance for international affairs, has acknowledged that Asians’ reluctance to impose policy on each other can be a disadvantage. Japan has now stated that it is prepared to play a leadership role, particularly to improve banking supervision. That move could be in Japan’s interest too, since the other Asian countries will have to think about a new peg, possibly to the yen or to a yen/dollar basket. Sakakibara points out that almost half the area’s trade is intra-regional.
For the time being, though, it is easy enough for banks to stay one step ahead of the authorities. The central banks are not sharing information, and they’ve lost sight of the real difficulties facing them – the economic problems of their own making and the political considerations that dictate their economic policies. Even Hong Kong is guilty of maintaining a peg for political reasons.
While aberrations persist in the currency markets, the Asian authorities won’t have killed speculation until they carry out the ultimate threat of executing the speculators – and all their bankers too.
