Credit Suisse executed its first trade on the Automated Foreign Exchange Securities platform in Switzerland 18 months ago. After a slow start, volumes have accelerated since November, with about 400 securities trading in Switzerland on the platform, where Credit Suisse is pioneering the product, according to Thomas. Credit Suisse hopes the product will evolve into a deep and liquid market that will be tradable across Europe, Asia and Latin America. The bank is hoping to capitalize on a growing trend whereby high-net-worth investors are allocating more of their investments to currencies.
“Our focus is on the global private bank centres: London, New York, Miami, Singapore, Hong Kong and Tokyo,” says Thomas. So far, two-thirds of business has been executed with external clients, and one-third with internal private bank clients, he adds.
Consultancy Celent estimates that FX holdings in high-net-worth individuals’ portfolios increased two percentage points to 10% in 2011. Those estimates are based only on direct FX holdings: that is, if the wealth manager allocates FX in a portfolio.
Dual-currency deposits are regarded as the most common FX structured products and are popular as a short-term yield-enhancement strategy and a cash management alternative, especially in the current low-yield environment. Thousands of trades are executed a day, but typically on an over-the counter basis. The trade is popular with investors of all kinds, particularly private banking clients.
By launching the tradable product last year, Credit Suisse is seeking to position for a new marketplace where regulators are pushing for the increased use of exchange-traded products by fully automating the pricing, issuance and settlement of the product, and standardizing it so it can be traded on AFS.
That will reduce the cost of the exposure, allow investments in smaller ticket sizes and give investors comfort in the face of regulatory uncertainty surrounding OTC products, says Thomas.
In a dual-currency security, the investor sells a call option on the investment currency and receives the premium, which is essentially the yield enhancement. The risk is that, at maturity, the underlying currency of the original investment has risen to, or above, the level at which the strike rate of the option has been placed. For example, if an investor does a EURUSD trade and gets paid a 10% return on euros, but if the euro rises from a current level of 1.3550 to 1.40, then the notional cash deposit and yield get converted to dollars, and the investor receives US dollars back rather than euros.
The product has an average annualized return of about 8% to 10% on a short-dated investment, usually with a two-week maturity. The maximum return depends on the strike placement and volatility, which can be anywhere up to 40%. However the higher the enhanced yield the higher the probability of conversion at maturity.