South Africa's FX Markets

Over the past 10 years, since the end of apartheid, the South African rand has matured into a fully functional world-class unit of exchange. The currency is traded in most major centres globally, with the volumes out of London leading the way. The five major local banks, namely Standard Bank, Investec, Nedbank, Absa and Firstrand have offshore representation and dealing capabilities in order to facilitate trade. Added to this are the 10 big global players that are also active in the rand market.

The rand is the second most actively traded emerging market currency, second only to the Singapore dollar (according to the latest survey by the bank of international settlements) and trade is about to increase further with the admittance of the rand to CLS, a settlement system that effectively guarantees settlement across time zones and eliminates settlement risk.

Triennial Central Bank Survey of FX Market Percentage Share for April 2004

Increased Participation

Apart from the hiccup that occurred with the run on the rand in 2001, volumes in the currency have been steadily increasing. Participation in the market has also been on the rise, with many global banks opening rand desks as corporate interest grows in what can be described as the gateway to Africa. The growing level of enthusiasm in the rand markets and country as a whole can be demonstrated by the current Barclays offer for Absa, South Africa’s largest retail bank. This has been the largest deal by a foreign entity in the South African financial arena ever and will result in foreign direct investment of about R33bn (US$5.14bn).

The Market

The speculative aspect of the market is largely housed within the banking environment, with the ability of local institutions and funds to participate in the market restricted due to exchange controls. This however, is changing and we are seeing a gradual and measured pace of exchange control relaxation. Emerging markets traditionally have some form of restriction on the flow of currency due to the fact that their economies are not developed enough to allow for full convertibility. Offshore there are numerous active participants in the rand market, from pension and hedge funds, to model and CTA accounts using the rand as a hedge against either commodity moves or emerging market gyrations. Hedge fund activity has been on the increase and the turnover in the daily FX markets across the globe has been on the rise, with the rand a benefactor along the way. The major reason for this has been the re-emergence of currency being looked at as an asset class on its own. The rand being a “high yielder” has attracted the attention of these hedge funds which traditionally look for superior returns than those achievable in more developed markets, albeit with a higher risk element.

Sophistication of the South African FX Market

The South African forex market is the most developed in Africa and is comparable to many first-world countries in its level of sophistication. The maturity of the market can be seen by the depth of instruments available for hedging purposes, as well as the structuring capabilities of the local banks for the corporate or institutional clientele.

• Spot market: The rand spot market is liquid and well supported. Spreads can however widen over holiday periods where activity diminishes. That said, the risk of not being able to find a price or exit a position is minuscule. There is an active market in the crosses and currency swaps are widely used. The market is supported via an infrastructure of order matching systems such as Reuters Dealer 3000 and by a number of Inter-dealer brokers.
• Derivative market: There are a number of solutions present in derivative markets for those investors exposed to the rand. The range stretches from plain vanilla type forwards, to barrier options and yield structures. The derivative markets are where the improvements are most visible. The South African corporate has matured, and by investing on an international scale require international standards when addressing risk management. The banks have been quick to respond. The traditional forward exchange contract is available; however, modifications to these have sprung up, including participating forwards, range forwards and the like. On the options front, zero-cost solutions and barrier type structures are gaining favour. These instruments are available both locally and abroad, thus adding further depth to the market.

Net average daily turnover on the SA forex market (US$ millions)

Source South African Reserve Bank

The Future

The future for the financial markets in South Africa is rosy. The level of interest is growing. Bankers, who are traditionally risk averse are landing on African soil looking for opportunities, their starting point is South Africa. Barclays the British behemoth is back, after leaving during the apartheid era, their investment totals some R33bn. Furthermore there is talk of Standard Chartered looking for a South African purchase to increase its African footprint with Firstrand a much spoken of target. With the arrival of these foreign players come new ideas and new skills to add to the thirsty South African markets. We could well see the rand joining the ranks of the more developed currencies in years to come. There is however one point that will need to be addressed and that is exchange controls. Barring any economic shocks such as 9/11, these are likely to be lifted over the next few years in line with the general building of reserves. With foreign direct investment on the increase, these reserves will be built reasonably quickly adding to the underlying positive sentiment on the rand. Furthermore, as these FDI inflows materialise, so the level of transacting in the rand will also escalate.