Korea's FX Ambitions: A Glimpse at Success and Benefits of Proposed Reforms
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The won's FX peer group
Before looking at the benefits of these proposed reforms, perhaps we should be asking what success would look like. For example, the Korean won already sees the largest NDF trading volumes in London, but as a deliverable currency, what should it be aiming for?
Daily trading volume by FX product and average daily trading volume (US$m of NDF mkt in London)
If developed market status is the ambition, then the APAC members of the MSCI Developed Market index are Australia, Hong Kong, Japan, New Zealand and Singapore. Korea is roughly a similar-sized economy to Australia, while its economy is around three times larger than Singapore. Yet, Asian countries are quite heterogeneous in terms of economic structure, trade dependence, and capital market size, although they are all quite dependent on trade with China.
If we narrow our focus more to the FX trading side, we can see from Bank of International Settlement (BIS) data that the average daily trading volumes for all KRW FX instruments (spot, FX swaps, outright forwards, and options) was $142bn per day in 2022. Korea could well be setting its sights on the sort of total FX volumes being enjoyed by Singapore ($182bn) or Hong Kong ($193bn). For reference, CNY daily FX volumes were $526bn in 2022.
The benefits
The first obvious benefit of these reforms would be the expected narrowing in bid/offer spreads. We see two paths here. The first is that the extension of onshore KRW trading hours should reduce the illiquidity premia currently embedded in the out-of-hours bid/offer spread. The second path is higher trading volumes driving USD/KRW bid-offer spreads narrower towards those potential targets such as USD/SGD, USD/HKD, or even USD/CNH.
In the chart below, we look at the average bid/offer spreads to mid-price for selected pairs between 2 June and 23 August. The data has kindly been provided by ING’s eFX team. The two standouts here: USD/KRW bid/offer spreads are nearly double when the onshore market is closed and USD/KRW onshore spreads are around 11 times wider than for the likes of USD/SGD, USD/HKD, and USD/CNH. Clearly, there is plenty of room for narrower spreads here.
Average bid-offer spread to mid-price of USD/KRW and selected Asian pairs
1m KRW NDF Asia hours spread = 100
The second benefit involves the risk management of positions. Currently, offshore entities are hedging exposure to the KRW by using the NDF market. This is cash-settled, usually in dollars, against an official NDF fixing provided by local authorities. Presumably, the liquidity of using a more widely traded FX-swap market to hedge positions will reduce slippage. There have also been extreme cases in Argentina and Ukraine where the local NDF fixings have failed to reflect market developments – effectively undermining the NDF contract as a hedging product.
