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What drives the growth in FX activity? Interpreting the 2007 triennial survey 1
The most recent BIS triennial survey shows that turnover in foreign exchange markets increased by more than 70% over the three years to April 2007. Two specific findings stand out. First, the growth in transactions between banks investors and with other financial institutions was particularly strong, consistent diversification with the increasing importance
funds, as well as portfolio
horizon, such as pension funds. Second, there has been a marked increase in turnover involving emerging market currencies. JEL classification: F31, G15, G20.
Market Activity shows that turnover in traditional foreign exchange significantly to $3.2 trillion in April 2007 (Table 1).2 The 71 % the Although this strong,
growth since April 2004, the previous survey date, was an unprecedented at current exchange rates and 65% at constant exchange rates." pickup in the growth of foreign exchange swaps was growth was broadly based across traditional foreign exchange instruments, particularly
increasing to 82% from 44% over the previous three years. Turnover in foreign exchange derivatives, Trends reporting such as currency swaps and foreign exchange options, of turnover commercial institutions, by different types of counterparty investment increased even more rapidly, albeit from a very small base. in the growth typically established in earlier surveys have continued. The increase in trading between dealers, and, to a lesser extent, including hedge funds banks, and other financial and pension
The views expressed in this article are those of the authors and do not necessarily reflect those of the BIS. We would like to thank Paola Gallardo and Carlos Mallo, who coordinated and compiled the triennial survey statistics, and Jhuvesh Sobrun for research assistance. The survey was conducted in April 2007 by 54 central banks and monetary authorities. They collected data on turnover in traditional foreign exchange markets - spot, outright forwards and foreign exchange swaps - as well as over-the-counter currency and interest rate derivatives. All figures presented here are based on preliminary results released in September 2007. The valuation effects are driven primarily between April 2004 and April 2007. by the depreciation of the dollar and the yen
BIS Quarterly Review, December 2007
December 007 2 .714 128 3.235 527 1.210 3.490 1. short-term traders. was particularly notable: customers the share of this trade in total between Table1 turnover reporting to the trading funds.896 % share % share 1. Correspondingly.005 362 1.200 1. increased level from 33% to 40% (Table 2). trading between reporting dealers captured 43% to 53% in 2004 and 64% in 1998. The share of trading also rose.099 % share 2007 Amount 3.083 1.190 1. given differences centres. dealers and non-financial it held continued 17%.319 1.174 689 329 156 499 674 % share 2004 Amount 1. Excluding stimated apsinreporting. The survey changes particular. market financial for the geographical the importance exchange underlying This special turnover of foreign exchange for different of these currencies in more detail. This trend is that there have been small but significant of foreign exchange turnover. looks at some of the trends The first section the increase in turnover with other financial made by leveraged through strategies diversifying explores institutions.880 1.429 908 279 242 657 772 100 64 20 17 46 54 100 59 28 13 43 57 100 53 33 14 38 62 100 43 40 17 38 62 Table2 Adjusted forlocalandcross-border double-counting. in billionsof US dollars 1992 Spot transactions Outright forwards Foreign exchange swaps Estimated gaps in reporting Total Memo: Total at April 2007 exchange rates 1 1995 494 97 546 53 1. exploiting it looks at the contribution profit opportunities a longer-term The second horizon section investors such as the carry trade.420 2004 621 208 944 107 1. reaching the share in 1992-98. in billionsof US dollars 1998 Amount Total" With reporting dealers With other financial institutions With non-financial customers Local Cross-border 1 2001 Amount 1.Global foreign exchange market turnover' Dailyaveragesin April.185 1.773 936 585 252 674 1. 2 e g 64 BIS QuarterlyReview.150 1998 568 128 734 61 1.950 2007 1. of the total market. In April 2007. in traditional foreign focuses on the factors In particular. by investors with and by algorithmic of emerging importance their portfolios the growing Foreign exchange market turnover by counterparty' Daily averagesin April.650 2001 387 131 656 26 1. potentially in the data also indicate currency composition longer-term the presence of emerging paints to significant distribution feature trends that may have implications sales. compared present across instruments. In This in market currencies has increased.210 394 58 324 43 820 880 Adjusted forlocalandcross-border double-counting. recovering of interbank to fall.
an investors. Global Financial Data.5 -1. Leveraged investors. currency funds. BIS Quarterly Review. pension funds. investors mostly such as for foreign trading First. as well as mutual funds. US HY = Merrill Lynch US dollar high-yield corporate index. played an important role Market that leveraged hedge funds have been primary players in foreign exchange market activity in recent years. leveraged retail investors also appear to be a growing Sharpe ratios 1 2. EME = MSCI emerging markets equity index.0 0.0 1.5 < N Z o 1. In addition.5 0 -0.0 1.5 1. which exchange.5 2. The final section concludes. Finally. Rapid growth in turnover with financial customers" Financial customers were the main d river of tu rnover growth Financial customers were the main drivers of the strong rise in global turnover.0 0. other financial subsidiaries of corporate firms and central banks. December 2007 65 . such as smaller commercial banks. 4 The term "financial customers" as used here is equivalent to the term "other financial institutions" in the triennial survey.0 1. insurance companies. can be regarded as a continuation short investment term investment has created increase horizons attractive and indirect of earlier trends (Galati and Melvin (2004». Merrill Lynch. such as hedge funds. foreign exchange markets have offered leveraged investors with relatively horizon have been actively diversifying demand algorithmic has suggested direct in high-frequency commentary by some investment banks. Carry trade returns are calculated as the returns on a US dollar collateral account from a strategy of borrowing in yen with a leverage ratio of 10. Second. Growth in this segment has accounted for half of the increase in total turnover over the past three years. allowing for profits and losses to be cumulated. as such. JPMorgan Chase. investors with a longertheir portfolios. returns.0 Carry trade Bonds Equity Carry trade Bonds Equity Carry trade Bonds Equity AUD = Australian dollar.5 0 -0. NZD = New Zealand dollar.0 iii ::2: o :::l <z Cl N 0 -0.0 o Cl :::l N -c z o o LlJ 1. to buy an Australian or New Zealand dollar deposit for one month. US A = Merrill Lynch US dollar A-rated corporate index. leasing companies. compared with 29% for interbank trading and 21 % for the non-financial customer segment. The one-month US dollar Libor rate is taken as the risk-free rate.5 -1. particularly in the spot market. All bond and equity indices are in US dollars.5 -1. investment banks and securities houses.5 Cl :::l 2. money market funds. This term covers all non-reporting financial institutions. hedge funds.0 0. sap = sap 500 equity index. EMBIGD = JPMorgan Chase EMBI Global Diversified index. has also increased turnover. Graph 1 Sources: Bloomberg. 1 Calculated as the ratio of annualised excess returns to the annualised standard deviation of returns. many of which were noted in previous surveys and. building societies.currencies and the implications this has had for different financial centres. This growth can be explained by several factors. Datastream. BIS calculations.
presence in foreign exchange markets. 66 BIS Quarterly Review. currencies Zealand April 2004 and exchange triennial particularly rate trends in an environment survey statistics show that of low several and New between financial market volatility.NZD 6 PLN 4 • 6 6 4 DK' eeAD EK 4 HKD 2 2 'NOK ~. Sources: Datastream. with adjusted R2 of 0. it is difficult to obtain precise numbers. BIS calculations. and April is a positive correlation between growth in turnover and the level of domestic interest rates of these investment strategies to overall turnover has Funds managed by leveraged investors have increased across instruments (Graph 2). although the impact of these investors on global turnover is still relatively small and the degree of leverage is not likely to be large (Galati et al (2007)). relatively cheap funding and benign conditions in financial markets.14.ZAR • MXN 8 . have been profitable over the past three years (Galati Graph 1). it is clear that hedge fund or the of assets under management in hedge fund activity In addition number of funds. left-hand been amplified by the increase in the funds managed by leveraged investors.29 and 0. has increased significantly and centre The growth States concentrated in the United over the past six years (Graph 3. respectively. For an analysis of the role of the carry trade in Asia. and the vertical axis indicates the average between April 2004 and April 2007 of the three-month interest rate. such as the Australian strong growth in turnover broadly. strategies such as the carry trade.I'lU~ . The line is obtained from an OlS regression. 0 0 100 200 300 400 500 0 100 200 300 400 500 0 0 100 200 300 400 500 0 The horizontal axis indicates the percentage change between 2004 and 2007 of foreign exchange turnover. see Gyntelberg and Remolona (in this issue). The contribution Although activity. centre and right-hand panels. there (Table 3).5 More Carry trades have been a popular investment strategy more access to margin accounts through such as Deutsche Bank's services targeted at retail traders.ZAR . The experienced 2007 identified as carry trade targets. hedge fund Turnover and interest rates Spot Outright forwards FXswaps • HU~ ~XN 8 8 .02 for the left-hand. December 2007 . national data.TWD CHF. Graph 2 This is true even after taking into account valuation effects arising from exchange rate changes and an increase in the share of Australian dollar turnover due to refinements in the data collection process. dollars.SGD 2 . has been to to access and London. Both axes show figures in per cent. which use leverage to exploit interest rate differentials et al (2007). Indeed. measured by either estimates panels). 0. One of the factors driving this trend is that retail investors have had significantly online trading dbFX.
2 0.2 0. similarly investment to investors activities. December 2007 67 .3 0.2 2.2 200 15. See also footnote 10 on page e.2 US dollar Euro Japanese yen Pound sterling Swiss franc Australian dollar Canadian dollar Swedish krona Hong Kong dollar Norwegian krone New Zealand dollar Mexican peso Singapore dollar Korean won South African rand Danish krone Russian rouble Polish zloty Indian rupee Chinese renminbi New Taiwan dollar Brazilian real All currencies Emerging market currenclas'' Asia" Latin America" Central and eastern Europe5 . for example a hedge fund.8 0.0 16.2 20.7 1. percentage shares 2001 1 2004 90.1 0. a customer. markets such as has benefited pension horizon. 4 Includes the listed Latin American currencies as well as the Chilean and Colombian pesos.5 1.4 0. This reflects with a shorter-term With prime brokerage. the Hungarian forint. Table 3 growth in foreign exchange investors.9 1.8 2. the Norwegian krone.4 200 19.1 2.4 0.8 0. the Philippine peso and the Thai baht.5 2.3 1.9 0.2 2.5 0.9 6.3 37. BIS Quarterly Review.8 7.Foreign exchange turnover by currency Daily averages in April." Institutional managers forces.5 0.3 0.7 1. The figures are adjusted for local and cross-border double-counting. the New Zealand dollar and the Danish krone.3 16.4 200 16.5 1.7 37.9 1. can obtain liquidity from a variety of sources while at the same time maintaining a credit relationship. Because two currencies are involved in each transaction.8 0.7 4.2 0.0 1.4 0.0 1. funds with a longer-term investment have also been more active a number of driving horizon.5 4.2 1.2 1.2 1.8 0.4 37.9 0.9 0.1 5.1 0. the Malaysian ringgit.2 1.1 88.7 0. these investors in their cross-currency First.7 22.7 0.the prime broker (Foreign Exchange Committee (2005)).1 1.3 1.0 0.3 1.0 6.0 1. 2 Defined as the residual after accounting for the top eight currencies.5 2007 86.8 2.9 4.5 15.2 4.1 4.6 5. from the development and investment of trust prime brokerage services.1 0. 5 Includes the Czech koruna.6 1.9 0. the Russian rouble.8 2.8 6.7 13.0 0. placing collateral and settling transactions with a single bank .3 6. 3 Includes the listed currencies of emerging Asian economies as well as the Indonesian rupiah. the sum of the percentage shares of individual currencies totals 200% instead of 100%.4 0. the Polish zloty and the Slovak koruna.
5 60 6 1. risk to be hedged investment A third driving force is that the value of funds managed Data on Japanese these investors panel). provide a specific example of the latter two factors at work (Graph 3. for the increase in turnover hedge (The trading are Algorithmic trading has boosted turnover reporting institutions. There The growth in this market segment owes much trading systems. the portfolios taken a more active approach to the management of currency diversified increasingly exchange internationally the greater and by trusts by developments that allow foreign in financial markets." Managed funds c::=::::J if otal -London -New York (NY) -US excluding [\1'1': 1. In trillions of yen. Investment Trust Association Japan. right-hand factor likely to have been important dealers and other financial is the growing in exchange banks. IFSL. Graph 3 Sources: Hedge Fund Research (HFR). a process by which investors manage their foreign exchange positions more actively and manage their currency exposures separately (Galati and Melvin (2004)). availability regulatory viewed foreign exchange returns on international manage encouraged have become as a distinct investments. This style of trading is designed rules.7 2 0. traders frequencies.1 50 4 0. December 2007 . in thousands. One aspect of this approach is the increasing use of currency overlay.8 trading generates have tried to exploit in carry trade at very high to the relative size of the positions. 2 Number of funds reporting to the HFR database. of instruments changes. profitability turnover high to exploit available algorithmic based on a set of predetermined changes Algorithmic in technology (2006)). trading has boosted the announced plans to create a 68 BIS Quarterly Review. Another between Economist has grown significantly.3 30 98 99 00 01 02 03 04 05 06 1 o 03 04 05 06 07 0 98 99 00 01 02 03 04 05 06 07 3 In trillions of US dollars. particularly funds and investment high-frequency electronically. The Banker (2007) reported that the continuing rise in algorithmic business of electronic brokers in the interbank segment. Reuters and the Chicago Mercantile Exchange joint platform that would support the use of algorithmic trading. underlying to advances market (Kos role of algorithmic rate quotes that (2007).have increasingly view to improving these institutions (CGFS (2007))." asset class and have exposure with a Second. In early 2007. Pengelly movements (2007)). For example. anecdotal particularly that in the spot algorithmic is also evidence in electronic to a significant traders have contributed rise in futures market activity.
the Malaysian ringgit. in particular. As a result. and so provide an upper bound. the share of currency trade between non-resident has increased significantly.10 The largest growth turnover for emerging market currencies were in transactions and non-financial customers (157%). China Citic Bank is quoted in market commentary $3. markets economies. mostly in Hong Kong. the Mexican peso. counterparties including the Brazilian real. which then into the also foreign made exchange significant especially segment. but is probably larger in earlier surveys. 11 BIS Quarterly Review. and financial customers (144%).php. Chinese nationals raised $9 billion on equity markets. The volume of IPOs on the Hong Kong stock exchange has been very high in recent years. Another interesting development for emerging market currencies is that. A wide range of currencies contributions to overall turnover. The degree of overestimation in the 2007 survey is likely to be less than one percentage point. as banks swap US dollars for Hong Kong dollars. www. A marked rise in activity in Hong Kong dollars The rise in turnover was particularly pronounced for the Hong Kong dollar. Some emerging market currencies. the Indonesian rupiah. Over the past three years. and occurred across all three traditional foreign exchange instruments. faster than aggregate turnover. an unusually large amount. averaging $2 billion per month (BIS (2007)). This issue will be discussed in more detail in the final report on the triennial survey. most of which are related to initial public offerings (IPOs) by Chinese companies in Hong Kong. This increase is likely to reflect Hong Kong SAR's ties with China and. 2007. the Mexican peso. December 2007 69 .The rising importance of emerging market currencies Fast growth in emerging market currency turnover The results of the latest triennial survey also show that turnover involving emerging market currencies grew significantly side of almost 20% of all transactions. in many cases. a segment generally assets closely with economic growth and trade. the recent wave of equity flows. the Polish zloty. the Polish zloty and the Turkish lira. experienced share of offshore trade. the share is still counterparties currencies emerging in emerging very large increases in the with non-resident compared to lower of trading generally of industrial and is particularly low for most Asian market currencies. As such. 11 as having activities derivatives growth in These the generate sizeable money market activity. 10 These estimates assume that unidentified currencies are emerging market currencies.7 billion in Hong Kong in April market. due to be released in December 2007. raised spills other about over In April 2007. as buyers seek funding. However. emerging market currencies are estimated to be on at least one compared to less than 15% in April 2004 rates in more very between banks identified and less than 17% in April 2001 (Table 3). the estimate of 15.iht.6% in Table 3 should be treated as a generous upper bound. For example.com/articles/2007104/20/news/citic. the Singapore dollar and the South African rand. attractive risk-adjusted emerging market financial have offered returns (Graph 1). Offshore trading of emerging market currencies has increased including the Indian rupee. This partly reflects the strong growth in many of these economies and the ongoing trend towards deepening financial markets in the Asian region (Ho et al (2005)). partly because a number of these economies place some restrictions on offshore trading activity.
1 (26) 12.9 16.8 (% aggregate) 158. Conclusions The latest triennial exchange feature market examined survey turnover two revealed between noteworthy an exceptional results: the increase growing in global foreign This special of importance April 2004 and April 2007.5 Netof localinter-dealer double-counting. and two thirds of swaps.6 241.0 1.1 (62) 9. are the Hong Kong dollar. unevenly centres (Table 4).0 Nonfinancial customer 17.2 62.9 1. spot transactions half of the turnover currencies particular currencies other's is traded. centres renminbi. centre panel).7 238. as Australia. the Polish zloty and the although a broad spectrum South African rand.1 663. In addition to trade in each Singapore currencies. For the United States.2 0. in billionsof US dollars Emergingmarketcurrencies Reporting dealer Other financial institution 72. are more important for by foreign exchange market currencies and.2 1. The importance non-deliverable relatively other financial forward centres. 70 BIS QuarterlyReview.6 169.6 (6) 109.0 8.5 (12) 174. in the Chinese currencies Japan and Korean won. than local ones. of these with non-reporting have the largest volume of emerging of this turnover institutions in these centres transactions is accounted is relatively for by transactions Largestoffshore centres are the UnitedKingdom and the United States high.6 (5) 13. relatively small volumes of emerging market currency trading.9 3.8 41. For the United Kingdom. The most important account for almost of emerging market in for the of Singaporeand HongKong are very importantfor Asian currencies currencies.0 (5) Total Aggregate turnover United Kingdom United States Switzerland Japan Hong Kong SAR Australia 1 68. owing to the large presence (Graph 3. turnover is dominated by Latin American offshore the Mexican peso and the Brazilian real.4 174. Table4 Offshore across financial the share financial institutions cross-border the turnover emerging trading in emerging market currencies is distributed trading. the Indian rupee and the New Taiwan dollar.Foreign exchange turnover by country and currency' April 2007.359.9 5. and Hong Kong are important market economies is significant contracts such there turnover financial of emerging in Asia. Switzerland.7 10. high share of forward contracts in aggregate in the have In contrast.5 2.6 85.December 007 2 . The United Kingdom market currency accounted and the United States In both cases. in these is reflected turnover.6 70.2 6.6 1.
Some of the drivers of these results seem to reflect structural changes and are therefore likely to continue affecting developments in foreign exchange by longer-term there is turnover. which were put forward as explanations for the falling share of the transactions has interbank market in previous surveys. the increase in portfolio diversification the extent that some home bias in investment potential for further diversification behaviour fund managers appears to be the result of a fundamental shift in approach. have a stronger focus on these currencies. Indeed. this could for the geographical distribution of foreign exchange activity given that some financial centres. such as Hong Kong and Singapore. between banks that are market-makers institutions continues institutions increasingly and other financial to become less apparent as these provide market liquidity. this is dependent robust growth.. The concentration of the banking sector and the increased efficiency driven by the spread of electronic broking platforms. the growth in interbank segment segments. In contrast. December 2007 71 .. do not appear to have been as important over the past three years. while some earlier trends appear to have run their course Other structural trends noted in previous analyses of triennial surveys appear not to have had a significant impact. to boost turnover between reporting dealers and financial customers going forward. The expansion of activity by leveraged retail traders could also add momentum to this trend. although economies continuing to experience horizon. such as those following on factors such as financial carry market of foreign exchange as an asset class. between reporting dealers and other financial institutions and the increase in the turnover of emerging market currencies. To remains.. the growth of banking that playa number of different roles in foreign exchange markets.transactions Some trends are likely to continue to affect turnover . the strong growth in prime brokerage and the granting of access to electronic brokers in the interbank market to hedge funds (Jung (2007)). While transactions customers BIS Quarterly Review. although the effect on aggregate turnover is not clear. While the impact of this trend on aggregate turnover is difficult to assess. is more dependent volatility that affect the attractiveness is also likely going forward. Should the share of emerging market currencies have significant implications in total turnover continue to increase. This trend is underpinned by the consolidation in the banking industry. and the fall in the share of this by the more rapid growth of the other Several other developments will also be important Several other developments the distinction other financial organisations in foreign exchange markets are also having in the interbank market a profound impact.. it does suggest that the ability to characterise Another significant banks and their the behaviour of different counterparty types may become more difficult over time. can largely be explained been roughly steady over the past six years. First. For example. the potential role for investors with a shorter-term trade strategies. . on emerging market as well as a further Further above average growth in turnover in emerging market currencies deepening and opening of their domestic financial markets. development are is the expansion of multi bank electronic between direct still generally executed through trading platforms that cater to customer markets.
which are more likely to transact financial customers through electronic trading systems. ahead of the tape". (2005): Foreign exchange prime brokerage product overview and best practice recommendations. June. Kos. January. Partly as a result of pressure from customers seeking simultaneous dealing to become that have associated with one or several of the multi bank trading become operational have an established electronic platforms since the early 2000s. algorithmic trading. New York City. Galati. Ho. D (2006): "Recent volatility trends Risk. December. pp 36-7. August. Pengelly. in the form banks of single-dealer have tended platforms platforms. (2005): "Trading Asian currencies". the electronic trading platforms have already increased turnover by providing access to retail margin traders and tools for References Bank for International Settlements (2007): 77th Annual Report. Risk.dealing.12 business transacted steadily. 11 May. August. February. Indeed. 12 An exception to this are banks in Switzerland. March. G and M Melvin (2004): "Explaining Quarterly Review. G Ma and R N McCauley Quarterly Review. pp 49-58. The Banker (2007): "Writing's on the wall for sell-side middle men?". Committee on the Global Financial System (2007): "Institutional investors. The expansion of the role of multi bank turnover access prices and to trade with any of the participating is likely to increase access to market-makers. J (2007): "Take me to your interdealer". December 2007 . banks started to offer the advantages business sources. pp 67-74. A Heath and P McGuire (2007): "Evidence of carry trade activity". no 27. Galati. no 383. trading. with their 72 BIS Quarterly Review. Foreign Exchange Committee (2007): "Algorithmic CGFS publications. BIS in the foreign remarks at the Forex Network New York conference. Jung. C. M (2007): "Algos a go-go". September. BIS Quarterly Review. June. services access to their to several customer pricing on electronic trading platforms has increased of these trading In the early 1990s. exchange market". global savings and asset allocation". BIS the surge in FX turnover". The Economist p 85. Basel. pp 27-41. G. These systems allow customers to dealers with whom they by facilitating investors' credit relationship. pp 22-4.
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