Richard Olsen: Jorge, what in your view drove the recent drop in liquidity?

Jorge Villon: I believe the reduction in liquidity has come about from several factors. One is the consolidation of the FX market after the events of 1998, the surge in interest rates, and many other various financial crises not directly reflected in FX but in other asset prices. I think there has also been a shift in commercial and investment banks' risk capital allocation to trading businesses. That has obviously forced us to reevaluate how much risk we can actually warehouse and take down.

R: By what percent have people lowered their risk capacity, do you think?

JV: It's a very difficult thing to estimate, but I would venture to say from 25 to 50 percent.

R: So it really has been hard.

JV: I think so, yes.

R: And, in addition to that, you have the consolidation within banks and the mergers which have basically lowered it - from my experience - possibly another 50 percent. Is that too extreme?

JV: That would probably be too extreme. I think many of the people who stopped market making or have consolidated have been smaller players in the market and would not have taken that much liquidity out.

R: But don't you think that some of the big players which have now concentrated all their dealing into one or two or three major dealing rooms, has lowered liquidity significantly.

JV: Yes, I see your argument, and I would say that has certainly had some effect. As to how much, in terms of the percent, that's very difficult to ascertain, in my mind. I couldn't venture a guess. I know more or less how much risk we were taking in '98 and how much risk we're taking now, and I'm going to use this as a mean and say somewhere around 25 to 50 percent reduction in risk limits.

Just to continue some of the other factors. Post-1998 again, the level of risk which we just discussed has driven banks to shift their focus more toward fee-deriving businesses, so it has taken a lot away from us. In addition to that, certainly in the past few months, we've seen some of the large liquidity consumers of the market - such as some of the major hedge funds like Tiger and Soros - exit the market. There is also less activity from, say, some of the other large hedge funds such as Ross Capital. Even though we see them mostly as liquidity consumers, they also provide liquidity to the market as well, to market-makers certainly. I believe that has affected the amount of transactions and liquidity in the market.

On the positive side, the e-commerce evolution in the FX market is picking up steam. I certainly think that the transparency provided in this market would be able to reestablish deeper liquidity due to that transparency, and that the alliances and consortia being brought together by the market will help in reestablishing some of our lost liquidity.

R: So, from your point of view, those big drives towards the e-commerce aspect can generate a new type of liquidity. Is that correct?

JV: Yes, specifically in the past two to three months, there have been a number of publicized ventures with the major players in the market being involved to create a marketplace, for example, that would not only serve the Internet market but would really be a liquidity marketplace for end users, corporate clients, institutions, etc.

R: The extreme price movements - do you think they've been more frequent in the recent three years?

JV: We've seen some very extreme moves certainly relative to implied volatility or historical volatility. We saw the extremely high volatility spike of the yen in 98, smaller moves in the Euro dollar. Overall volatility in Euro dollars has basically run up by 50 to 75 percent of where it traded in its first year. I think we haven't seen a lot more discontinuous moves, and certainly at least a contributing factor would be this decrease in liquidity that we have seen in the market.

R: Do you think that's any reason for concern?

JV: The discrete moves or events we've seen are certainly a cause of concern for any market-maker trader and his option book, as the distributions that we use in our pricing models obviously do not account for such moves as frequently as we've been having them. So the price of protecting a business from such price movements has increased and perhaps that has also aided the decrease in liquidity as people are less willing to warehouse risk.

R: I'm always concerned with what happens in extreme market situations with derivatives. For derivatives portfolios you basically do a minimum of hedging, and it's like switching off your burglar alarm.

JV: Yes, that's an interesting analogy. Yes, I think that does happen. I think senior management's role is to look at the prices or event scenarios and perhaps use some gray hairs to establish patterns or look at cross-market relationships that might be leading indicators to market dislocation. Obviously, it's very difficult to predict, otherwise we probably wouldn't be having this conversation if we could predict when these dislocations will occur. But there are leading indicators, I believe, if you look cross-market that perhaps can give you early warning signals as to whether we should be seeking risk or shying away from it.

R: What is your assessment of the current market situation?

JV: I think the market is certainly moving to find e-commerce solutions. FX is a very mature and commoditized market and I believe well-suited to an e-commerce world. I think most banks have developed their own in-house products which have been deployed or are being deployed to their clients. However, I believe the client side is driving a multi-bank platform solution. I believe that the consortia and the alliances that are announced now almost on a weekly basis are very possibly a solution, in which clients will enjoy liquidity and transparency, price segregation, straight-through processing, et cetera. And I think it will make the FX market again be a leader in this technology.

R: Isn't it the case that all these FX portals are directed for transactions from a million dollars and larger and not really focused at the smaller transactions?

JV: I would say so, but these solutions are certainly scaleable. It depends on what the model is; whether it's geared towards providing liquidity or just transaction processing. I think we've had various platforms, which also offer solutions. So the "scale-ability" is there, where in the terms of processing a transaction, it doesn't really matter whether you're processing half a million dollars or five hundred. I think the more difficult part is really creating the depth in the market to be able to handle the five hundred million transaction ticket. Also, I think the focus has been really on increasing larger transactions, just because clients are averse to executing large transactions over the Internet, so perhaps the focus is aimed at making clients a bit more comfortable with that.

R: So, basically, it's kind of the focus of the professional FX community to make its product more attractive for the traditional professional market. Is that correct?

JV: Yes.

R: In my view, there has been a kind of slowdown in innovations in the FX market. What is your view on that?

JV: I think the growth in product innovation - I'll stress the growth that we saw in the early to mid-'90s - has tapered off partly because of some of the market events. Also, there have been some of the publicized client events, where clients were transacting complicated exotic products or structured products that were perhaps a bit too difficult for them to price or understand the risks involved. It affected the development cycle. However, I think the products that were well-established and popular have remained and become stable products within the market and are treated very much like vanilla.

R: Such as what products?

JV: The barriers, reverses, timers, range accruals, etc., are really main staples in our product base these days. Innovation has slowed to more cross-asset products or correlation products, quantitative products. So, there has been development but I would agree it has slowed from where we were in the early '90s.

R: Who do you think are the biggest players today in the FX market?

JV: I would say Deutsche Bank, Chase, Citibank, UBS, Barclays, BofA. How many more shall we list?

R: But they would make up roughly 70 percent of the market?

JV: Yes, a large portion of the market. I think if we add a few more names, like Dresdner, Morgan Stanley, Goldman's - probably the top ten banks make up 70 percent of the market.

R: From your point of view, the FX market is the leading market in terms of efficiency. Do you think it will remain there?

JV: In terms of efficiency, what exactly do you mean by that?

R: I mean, just spread…the spread is a fraction of what you pay for an equity transaction today.

JV: Yes, I think it will remain the most efficient market because it is a very active market. Even though we've lost some of the liquidity, we still have tremendous depth and volumes going through on a daily basis and, therefore, I think we will remain very efficient in our pricing.

R: Thanks so much for the interview.