Capital Markets

Basket Case

A new synthetic currency could limit the volatility in foreign exchange trading, as long as it doesn't overcomplicate matters.
Jason KaraianNovember 5, 2007

It is often said that two factors explain most movements in financial markets: fear and greed. Nowhere is this more true than in foreign exchange trading.

The recent volatility of the Japanese yen versus other industrialised countries’ currencies is a good example of the fast-changing “herd instinct” that drives currency markets, according to Bob Munro, chief economist at foreign exchange brokerage and consultancy HiFX. Highly leveraged speculators piling in and out of the “carry trade” — borrowing low-yielding currencies to buy higher-yielding ones — have taken the yen on a roller-coaster ride in recent months.

For companies that borrow in yen or other low-interest currencies, such as the Swiss franc, this volatility poses unwelcome problems. Barclays Capital figures it has come up with a solution in the form of a new synthetic currency, the European Borrowing Unit. A basket of short and long positions in 10 currencies versus the euro, the EBU carries a 0% interest rate and aims to limit volatility by rebalancing its portfolio every month.

Andy Kaufmann, co-head of FX structuring at Barclays Capital, expects the first EBU-denominated borrowings in a matter of weeks. The currency will appeal mainly to companies looking to hedge bond issues in yen or Swiss francs, offering “lower funding costs without as large long-term risks,” he says.

With the wide availability of information shrinking spreads, Munro of HiFX is generally wary of banks overcomplicating foreign exchange products to make up for lost profits. But, he says, “anything that waters down the effect of the yen could be useful.”