Foreign Exchange Activity in 2007
Foreign exchange market turnover
Global turnover
Turnover by counterparty
Currency composition
Foreign exchange market turnover
The April 2007 data on turnover in traditional foreign exchange markets highlight several important features of the evolution of these markets. First, average daily turnover has grown by an unprecedented 69% since April 2004, to $3.2 trillion (Table B.1). This increase was much stronger than the one observed between 2001 and 2004. Even abstracting from the valuation effects arising from exchange rate movements, average daily turnover rose by 63%.
Second, growth in turnover was broad-based across instruments. More than half of the increase in turnover can be accounted for by the growth in foreign exchange swaps, which rose 80% compared with 45% over the previous three-year period. Changes in hedging activity may have been one factor underlying the increasing importance of foreign exchange swap instruments. Growth in the turnover of outright forward contracts also picked up significantly to 73%. In contrast, turnover in spot markets increased by 59%, which is somewhat lower than the growth in turnover in the previous three-year period.
Third, the composition of turnover by counterparty changed substantially. Transactions between reporting dealers and non-reporting financial institutions, such as hedge funds, mutual funds, pension funds and insurance companies, more than doubled between April 2004 and April 2007 and contributed more than half of the increase in aggregate turnover (Table B.3). Factors underlying the strength of this segment include strong investor activity in an environment of trending exchange rates and low levels of financial market volatility, a trend shift among institutional investors with a longer-term investment horizon towards holding more internationally diversified portfolios and a marked increase in the levels of technical trading. Turnover between reporting dealers and non-financial customers also more than doubled. Consequently, the share of turnover resulting from transactions between reporting dealers, ie the interbank market, fell to 43%, despite growth in this segment being slightly lower than in the previous three-year period.
Fourth, the currency composition of turnover has become more diversified over the past three years (Table B.6). The share of the four largest currencies fell, although the US dollar/euro continued to be the most traded currency pair. The most notable increases in share were for the Hong Kong dollar, which has benefited from being associated with the economic expansion of China, and the New Zealand dollar, which has attracted attention from investors as a highyielding currency. More broadly, the share of emerging market currencies in total turnover has increased, to almost 20% in April 2007.
Finally, the geographical distribution of foreign exchange trading did not change significantly (Table B.2). Among countries with major financial centres, 2 Triennial Central Bank Survey 2007 Singapore, Switzerland and the United Kingdom gained market share, while the shares of Japan and the United States dropped. In some cases, changing shares reflected the relocation of desks.
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Global turnover
The 2007 survey shows an unprecedented rise in activity in traditional foreign exchange markets compared to 2004. Average daily turnover rose to $3.2 trillion in April 2007, an increase of 69% at current exchange rates and 63% at constant exchange rates (Table B.1). The ratio of foreign exchange turnover to the value of international trade and capital flows has increased somewhat over the past three years, recovering some of the decline observed in the 2001 triennial survey (Graph B.1).
Growth in turnover was broadly distributed across instruments. The expansion in FX swap turnover was particularly strong and made the largest contribution to aggregate growth. This is in contrast to the period between 2001 and 2004, when growth in FX swaps was significantly lower than that in spot contracts and outright forwards. The share of FX swap transactions accounted for by contracts with a maturity of less than seven days has increased to 78%, from 73% in April 2004, whereas the share of these short-term contracts in outright forward turnover has fallen slightly. In both cases, contracts with a duration exceeding one year command a relatively small share of the total.
The geographical distribution of foreign exchange trading typically changes slowly over time, and the 2007 results are no exception (Table B.2). Among countries with major financial centres, Singapore, Switzerland and the United Kingdom gained market share, while the shares of Japan and the United States dropped. In some cases, changing shares reflected the relocation of desks.
By counterparty, the expansion in turnover in the interbank market was comparable to growth over the previous three years, but was outpaced by the increase recorded in the non-financial customer and non-reporting financial institution segments, which more than doubled in size. The currency composition of foreign exchange turnover became a little more dispersed, with the combined share of the US dollar, the euro and the yen in overall turnover falling.
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Turnover by counterparty
Half of the growth in aggregate turnover can be attributed to an increase in transactions between reporting dealers and other non-reporting financial institutions, such as non-reporting banks, hedge funds, pension funds and insurance companies (Table B.3). Consequently, the share of this segment increased to 40% from 33%. This growth was broadly based across spot, outright forward and FX swap instruments.
Several factors are likely to have been important for the ongoing strength of turnover growth in this segment. Foreign exchange markets have offered investors with short-term horizons relatively attractive risk-adjusted returns over the three years to April 2007, given that exchange rates were broadly trending and financial market volatility was at historically low levels. In addition, there is evidence that longer-term investors, such as pension funds, have contributed to the increase in turnover by systematically diversifying their portfolios internationally.
The spread of electronic trading platforms has also contributed to turnover in this segment, in part because it has enabled large financial institutions to set up algorithmic trading systems, and has provided trading facilities to retail investors. The share of trade between reporting dealers and non-reporting financial institutions executed through electronic systems varies considerably across countries. In this segment, electronic execution accounts for almost 60% of turnover in Switzerland and around 50% in Australia, Germany and Hong Kong SAR, while the median share is 32%. The median share of electronic execution is 17% for non-financial customers.
Turnover between reporting dealers and non-financial customers also more than doubled between April 2004 and April 2007, but contributed less than one quarter to overall turnover growth. The increase in turnover betweenreporting dealers and non-financial customers is likely to be related to the substantial growth in international trade in goods and services between 2004 and 2007, and possibly to an expansion in hedging activity. FX swap turnover with non-financial customers underwent a particularly strong increase and now accounts for 45% of all turnover in this segment, a rise of 10 percentage points. Spot turnover experienced an offsetting fall in share, although it grew in line with aggregate spot turnover.
The growth in interbank transactions has been roughly steady over the past six years, and the interbank market contributed almost one third of the growth in aggregate turnover. Despite this, the share of the interbank market in total turnover fell to 43% from 53% over the past three years, largely because the growth in turnover for the other segments was so rapid. Some of the factors identified as drivers of the downward trend in the share of the interbank market in analyses of previous triennial surveys, such as the concentration of the banking sector and the spread of electronic broking platforms, may also have had a dampening effect on interbank turnover, but are not likely to have been as significant as hitherto.
Consolidation of the banking system was identified in the past as reducing turnover in the interbank market through channels such as efficiency gains and the ability to net trades across related parties within an organisation. Although it appears that the banking sector has continued to become more concentrated, the rate at which this is occurring has slowed significantly (Tables B.4 and D.1). In addition, there has been a small increase in the share of related party transactions in total turnover: the median share of related party trades has increased to 8.5% in 2007 from 7.5% in 2004. In general, the share of related party trades is lower in industrialised countries, and the median share of these trades has fallen to 4% from 7% for this group. The main exceptions are Australia and France, where the share of related party trades has increased to 22% and 14% respectively. The share for emerging market economies is generally higher and the median has increased to 14% from 10%.
Another factor that has been discussed as an important driver of efficiency gains and the falling share of interbank foreign exchange transactions is the spread of electronic broking platforms. Although it is difficult to assess the impact of changes in execution methods on trading volumes, it is clear that electronic broking systems play a very important role in some interbank markets. For example, for Germany and Switzerland 55% and 44%, respectively, of total interbank transactions are executed through electronic broking platforms. These shares rise to 67% and 58% when electronic trading systems are included in the calculation. However, the median share of transactions executed electronically in the interbank market is significantly
lower, at 34%, and in some countries, such as Belgium, the share is less than 10% of all interbank trades.
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Currency composition
Over the past three years, the share of turnover accounted for by currency pairs among the US dollar, euro and yen has declined by 6 percentage points (Table B.5). Most of this fall can be explained by the decline in the share of the US dollar/yen pair. The offsetting increase was mainly for transactions involving currencies with relatively low turnover, classified as “other” in Table B.5.
The increase in the dispersion of foreign exchange turnover by currency is also apparent in Table B.6. In 2007, the four most traded currencies, the US dollar, the euro, the yen and sterling, are involved in 8 percentage points fewer foreign exchange transactions than they were in 2004. Taking into account the valuation effects arising from the appreciation or deprecation of a currency relative to the US dollar, ie at constant exchange rates, yields a similar conclusion: while the share of the US dollar in total turnover increases, this is offset by larger declines in the shares of the euro and sterling (Table D.3).
Among the currencies with lower levels of turnover, the Hong Kong dollar, the New Zealand dollar, the Swiss franc, the Norwegian krone, the Australian dollar, the Swedish krona, the Polish zloty, the Chinese renminbi and the Indian rupee have all experienced a significant increase in their share of aggregate turnover at current exchange rates. In general, this remains true in constant exchange rate terms, although the share of the Australian dollar rises by 0.3 percentage points rather than by 0.8 percentage points and the share of the Canadian dollar falls by 0.5 percentage points rather than staying steady.
In some cases, such as the Australian and New Zealand dollars, the increase in turnover is likely to partly reflect greater investor activity in highyielding currencies between 2004 and 2007. For the Chinese renminbi, the Hong Kong dollar and the Indian rupee, the expansion in turnover is likely to be related to strong economic growth and the increasing depth and openness of domestic financial markets in these economies.
More broadly, there appears to have been an increase in the share of emerging market currencies in total turnover: in April 2007, emerging market currencies were involved in almost 20% of all transactions (Table B.6). Emerging market currencies are defined to be the residual when turnover in identified industrialised economy currencies is subtracted from aggregate turnover. This calculation assumes that currencies which are not separately identified4 are emerging market currencies. To the extent that this assumption does not hold exactly, the shares attributed to emerging market currencies in Table B.6 should be treated as upper bounds.
Based on data provided by countries that report on all industrialised economy currencies, it is likely that the degree of overestimation in 2007 is less than 1 percentage point. The degree of overestimation in previous surveys is likely to be larger given that changes implemented for the 2007 triennial survey have allowed for a more comprehensive reporting of currency breakdowns. In particular, changes to reporting forms have made it possible to report offshore trade in industrialised economy currencies more accurately (see Section D.6). For example, it is estimated that this change increased the share of the
Australian dollar by around 0.4 percentage points in 2007. This implies that the assumption that the residual currency can be classified as an emerging market currency is correspondingly more approximate in previous surveys.
The presence of a residual currency also suggests that the importance of some currencies in Table B.6 is significantly underestimated because they have not been separately identified. In some cases, this issue can be partially corrected following a procedure discussed in more detail in Section D.11. Estimates based on this adjustment indicate that the share of the Hong Kong dollar in overall turnover has been underestimated by at least 0.4 percentage points in Table B.6. This correction does not affect the estimates of the share of emerging market currencies insofar as it redistributes this share between two items that are each defined as emerging market currencies for the purposes of this table.
The results of the latest triennial survey also reveal that the instruments used to trade different currencies vary widely (Table B.7). For some currencies, notably the Chinese renminbi, the Russian rouble and the Turkish lira, over 60% of foreign exchange turnover is accounted for by spot transactions. Although forward transactions account for only 12% of turnover in aggregate, the share of forward transactions exceeds 25% in a number of Asian currencies. Many of these currencies have non-deliverable forward markets because of capital controls. In contrast, the share of turnover accounted for by FX swaps exceeds 70% for the Hong Kong dollar and the Norwegian krone.
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This Report was publishled by Bank for International Settlements.
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