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Off The Record

Confessions of a Corporate Forex Trader

Antagonism between corporates and dealers makes the forex world go round

The author is among the new breed of corporate forex traders who sprang up in the 1980s when multinationals, aware of their increased need to hedge, began raiding talent in the dealer community. He started at a small European bank, subsequently covered some of the world's largest multinationals as a forex salesman for a U.S. money center bank, and then crossed over to the corporate environment in 1986. He traded forex at a Fortune 100 corporation well-known for its financial acumen, and then at a European conglomerate. Now back on the Street investing firm capital in hedge funds, he spoke off the record to freely express his views of big shifts over the past decade in client-dealer relationships in forex.

A lot of people like me left banks to work for corporations and hedge funds in the 1980s. Because of this movement of talent, forex end-users became smarter and more efficient. When I traded forex for a corporate, I was determined to reduce transaction costs and tighten spreads. I'd come into the market not telling dealers whether I wanted to buy or sell. The dealers were not accustomed to this-and they didn't like it!

Previously, corporate treasuries were run by-or reported to-defensive accountants who went by the book. The culture is different now. Treasury, which usually reports directly to the chief financial officer, is more aggressive, more willing to use off-balance sheet products, and that's all for the good, except when they're misused-which they often are.

Banks are always trying to sell you products you can't mark to market yourself so they can build a spread into it. At the two big corporations I worked for, our approach was never to buy anything we couldn't price ourselves. We bought our own software and trained ourselves to understand it. Then we could compare our prices with the banks'. We also had a broker box so we could see the bid/offer spread and activity in the markets. Most corporate treasuries just get a Reuters screen, which doesn't offer the same insight.

Some dealers assumed that if they did the spot deal for us, we would be lazy and automatically give them the forward that would reverse the trade. We didn't. We shopped for the best forward price.

Sometimes when the market was difficult, we would give orders to two dealers and get two different prices. That way we judged the quality of execution-and checked if they were unloading proprietary positions before us. The dealers respected us for our smarts, but if they could nail us, they did. It's part of the game. We would nail them back.

Here's now we nailed them: We'd ask for a two-way quote after 3:30 p.m. in New York, when the broker dealers weren't trading. We knew they would have to give us a quote, since we were a big customer. Our order would move the illiquid market. Then we would take them out on the other side. The banks would scream! But after that kind of experience, they would be more careful with us.

Earned Respect

It took some dealers a little time to learn respect for us. For example, two years ago a junior option guy tried to screw me. I was tied up with something else and didn't have time to calculate the price for myself, so I just said, 'Do the trade.' When I calculated it later, I saw it was way overpriced, and asked him about it. He hemmed and hawed-so I went to his boss's boss in London, whom I had known for years. I ended up getting the market price, and that guy knew not to phone me again. But it was stupid of me not to price the deal myself first, I admit.

We watched the dealers like hawks-particularly after banks began seating their proprietary traders near their best corporate coverage guys, starting around 1990. We worried that the bank's proprietary traders-not its market makers-would see our orders and trade on them. It was very good for the bank, but as a customer, I had to wonder how information from us would be used. Would they treat me as a customer or front-run my trade? Front-running is illegal in equities, but in forex, anything goes.

The key is trustworthy counterparties. An end-user doesn't see the same information the big dealers see, so you need their help to understand the market. You want the bank to give you a good price, tell you there's something big going on in the market, and provide you with a good options strategy at a fair price.

Naturally, the deal has to be worthwhile for the dealer. If you can trust your dealer, you can let him work a big order. He'd rather get the full order instead of a little piece, and know that ten competitors aren't moving the market against him. If a dealer executed a trade well and didn't move the market, I'd sometimes give him a pip as a fee on top of his bid/ask spread. You're not supposed to do that, but why not? He earned it.

The kind of service worth such a fee is pretty rare. Greed is more common. Sometimes the large New York investment banks would get a big order from a corporation and decide not to lay it off on other dealers: If they packaged it for other clients they could make a spread on both sides. Some very bizarrely structured trades resulted from this.

I once took a call from an investment bank pushing a structured Canadian note tied to the Canadian/US exchange rate. I couldn't understand why the bank was so excited about this structure. I didn't need it, I hadn't asked for it. The truth was, no one needed it. The bank just needed to sell it. That's why a lot of corporations lost money in derivatives: They bought things they didn't need.

Tricky Markets

Today's markets are more difficult than those ten years ago. There's more event risk. I vividly remember the ERM break-up in 1993. I was on a golf course in New York late one Sunday afternoon, when I got an urgent call from the office. As the market was opening in New Zealand, it looked like the ERM's fixed bands were going to fall apart. We were trading against the bands, so our positions were starting to make big money. Our bet against the pound ended up doing great, because Britain devalued to save its economy. But we had a larger bet on the French franc versus the Deutschemark, which ended up losing money because we misread the political resolve of the French authorities to freeze the band and raise interest rates no matter what it did to their economy. The only country in Europe doing well economically now is the U.K., because they didn't decide to choke their economy in pursuit of monetary union.

Of course, that summer, when Soros broke the pound, people also realized that the hedge funds use leverage and are not afraid to have $5 billion positions. Those guys were slamming the market left and right. They brought huge volatility and liquidity.

Derivatives, too, are making the market trickier. When yen/dollar was at 85 this spring, people thought they couldn't make money on direction, so they sold volatility. Many sold options with strikes at 100. But then the Japanese adopted a stimulative fiscal package cutting short-term rates, and the G-7 started to intervene. Yen/dollar moved back toward 100 in the fall, and the spot moved as much as five percent in a day. That's huge! The moves came so fast because everyone had to delta hedge their short options positions. If you don't have the right position on, you can't react fast enough in a five percent daily move. Lots of people lost both on direction and on gamma. Some had sold volatility at 12, and had to buy it back at 24!

I was happy not to be in the market in late 1994 and 1995. To be sure, many banks made money on forex this year, but others gave back their gains when the yen/dollar moves failed to continue. This year was especially tricky, because you had to be opportunistic. When there was a move, you had to take your profits before they evaporated.

In some ways things are easier. Cash management and short term forex trading is being automated. But there's a lot more to corporate forex management than mere trading: Corporate treasuries have to understand their exposures and devise appropriate strategies. It's difficult to understand the business flows that create exposures. One major dealer told me recently that he puts his brightest people on the corporate coverage desks, where they can help treasurers put together hedging and refunding strategies. But understanding those business flows is treasury's job. When I read in the press about a CEO blaming company losses on a move in the dollar, I get angry. The treasury department should have known about the exposure. Treasury's job is to protect the company's profits.