Looking at the geographical distribution of OTC FX turnover, Galen Stops sees some areas of competition emerging amongst different trading centres, but argues that it will be a long time before we see the outcome of any moves being made now.

It will have come as no surprise that the data from the Bank for International Settlements’ (BIS) latest OTC FX turnover survey indicates that FX trading is still heavily concentrated in just a few geographical locations. In April 2019, sales desks in five locations – the UK, the US, Singapore, Hong Kong and Japan – intermediated 79% of all FX trading.

The ranking of these locations as FX trading hubs did not change in the latest survey, but despite this there were some significant fluctuations with regards to how much activity each saw.

For example, the share of FX trading taking place in the US declined from 19.5% in the 2016 survey to 16.5% in the latest one. David Newns, global head of Global Link Execution Services at State Street, suspects that this decline might be the result of regulations that have come into effect since the 2016 BIS survey.

As he explains: “We may be seeing an impact of MiFID II combined with the usage by global asset managers of complex netting functionality. Before MiFID II, an asset manager could execute the block via any multibank platform without much in the way of constraint around the legal entity that it used to execute that block. Under MiFID II, if the block contained any FX trades considered ‘financial instruments’ that would need to be settled for EU legal entities then the asset manager would have to execute those netted blocks on an MTF (if they wish to continue using a multibank platform) and most likely as a UK legal entity which had membership of the MTF. This would have the effect of apparently driving volumes up for London at the expense of the US and Asia.”

Optimism Around APAC

Indeed, the share of FX trading taking place in the major Asian financial centres of Hong Kong, Singapore and Tokyo declined slightly to a combined 20%, according to the lastest BIS figures. This decline was mainly driven by relatively slower growth in Singapore and a slight decline in trading activity in Japan as, by contrast, turnover in Hong Kong grew at a higher rate than the global aggregate, raising its share in global turnover by 1%.

This overall decline is perhaps somewhat surprising, given that APAC is generally talked about within the FX industry as a growth region, yet there are many reasons to remain optimistic about its future. For starters, this latest BIS survey is the first time that five of the top 10 FX trading hubs by volume have been in APAC.

Moreover, it is widely anticipated that the global economic centre of gravity will continue to shift towards this region — the Asian Development Bank forecasts that Asian economies’ share of global gross domestic product (GDP) will double from the 26% recorded in 2000 to 52% by 2050, while PwC says that the growth of assets under management (AUM) in APAC is set to outpace any other region globally, almost doubling from 2017 to 2025 when AUM is expected to be almost $30 trillion. Crucially, one source at a major bank in APAC points out that intra-Asian trade has continued to tick upwards in recent years, increasingly powered by large regional economies such as Vietnam, Indonesia and the Phillipines. Cross-border trade being a major source of FX flows, this is only good news for the trading hubs in the region.

These factors naturally suggest that FX trading volumes will continue to grow in APAC, and it is clear that Singapore, Hong Kong and mainland China have been on a fairly consistent upwards trajectory in terms of FX trading volumes this side of the millennium.

In fact, one of the more signficant data points to emerge from these latest BIS figures is that mainland China saw an 87% increase in FX trading activity compared to 2016, with an average of $136 billion traded there in April. As a result, it shot up the BIS global country rankings to become the eighth largest FX trading centre in the world.

A Rising China

The natural question then follows: could mainland China ultimately eclipse the other APAC FX hubs in terms of trading activity?

“I think definitely, yes,” says the CEO of one FX technology provider in Singapore. “It’s a market that is not active right now, but it’s one that is likely to grow. If you just look at Hong Kong alone it’s coming up the rankings in a very big way, so [China] will figure prominently going forward. The question will then be whether they want their own data centres onshore in China as well.”

However, a senior figure at a platform provider in the region urges caution when making predictions about mainland China becoming a major FX trading centre in the near future. They argue that it’s not clear that there is a commercial argument right now for firms locating technology and staff to support trading activity there.

“China is not a threat to other trading hubs in APAC in the short-term by any stretch of the imagination. It will be in the long-term just because of its size and amount of flow that will go through there eventually, but I don’t think that it’s transparent enough, I don’t think that the regulatory environment is in place and I don’t think that it’s an open or inclusive enough environment.”

The source adds: “[China] likes to keep control of all their systems and what goes on there, and that’s not the natural way of an FX market. So this is probably a 20-year play because we don’t even know how they’re going to open up their own currency and there’s capital controls all over the place still.”

The reason for the sharp increase in FX trading in mainland China is likely attributable to the various policies implemented by the Chinese government to develop its onshore markets and cross border trading through Hong Kong. With regards to the latter, there is now the Stock Connect and Bond Connect initiatives, which allow foreign investors to access China’s onshore trading platforms. One senior economist in the region says that these policies have encouraged so-called “south to north” flows from Hong Kong to mainland China which have contributed to onshore trading and also to renminbi trading.

Brexit Complications

The UK, meanwhile, saw its share of FX trading rise by 6% in the latest survey, accounting for 43% in total of global FX activity. But the obvious question here is: if Brexit does ever actually happen, will this begin to chip away at the UK’s position as the largest FX trading hub in the world?

Right now there are too many variables at play to make any confident predictions regarding Brexit, but there is a case to be made that if the UK leaves Europe without a Brexit deal — or leaves with a deal but under acrimonoius circumstances — then this could be detrimental to London’s position as a major financial centre.

For starters, there could be a sharp outfow of talent and human capital as non-UK citizens either find their status as residents in the capital under threat or simply decide that they’re better off on the continent. This last point could be exacerbated by the fact that other cities are making a big push to woo skilled finance workers. For example, Paris is offering a special “re-patriot” tax rate that is lower than the regular French rate to entice senior figures to return to the country post-Brexit.

More importantly, it is unclear what access the UK will have to financial markets in Europe, and vice versa, after Brexit happens. It might be that any exit deal allows for trading, and commerce in general, to continue on largely undisturbed, but Britain’s departure from the EU could equally throw up numerous barriers and create new friction points, making it harder to conduct business between the two. It could also raise questions about whether the EU will allow the UK to continue clearing euros, with more than one source predicting that if Brexit does indeed happen it is likely to prompt a renewed push to develop a larger clearing centre on the continent.

Then there is the regulatory angle. Regardless of one’s views on Brexit, it was hard not to appreciate the irony of news reports immediately after the vote in 2016 which suggested that financial services firms that had previously been looking for loopholes to avoid the MiFID II regulations were now suddenly looking for ways to ensure that they did come within scope of these rules in order to ensure that they weren’t cut off from European markets. The UK might loosen regulations in order to attract more finance services business, but could this be negated if its biggest trading partner, the EU, retaliates in response? It’s possible.

The BIS data shows however, from an FX perspective at least, that the last three years of Brexit uncertainty hasn’t been to the detriment of the UK’s standing as a trading hub, and whatever its future relationship with Europe, it retains some important advantages. It’s geographical location between Asia and the US means that it is, literally, well positioned to continue as an important trading hub, while the existing network effects of having so much human talent and additional support services concentrated in one area tend to be reinforcing.

“It would be interesting to see how much the concentration of quality talent and infrastructure that supports the FX activity in London offsets any effects of Brexit,” says Newns.

Yes, statistics show that more banks are shrinking their offices in the UK, but the senior economist claims that this is more of a post-financial crisis phenomenon rather than a Brexit related one. They add that anecdotally they hear that many banks are sniffing out locations on the continent to move their operations to, but they haven’t seen much evidence of an actual shift taking place just yet. Therefore, they argue that any impact that Brexit might have on the UK as a trading hub is only likely to be felt over a much longer time horizon.

Looking at geographical FX trading patterns in percentage terms only emphasises the point that any changes that occur within the industry are likely to happen only over a very long period of time. The UK remains miles ahead of the US in terms of FX trading activity, while the US sees more than double the volume of the next largest hub, Singapore, which in turn has more than double the FX trading volume taking place there than any of the centres ranked fifth or lower by the BIS numbers. And for all the talk of Brexit, a rising China and economic growth in APAC, these statistics won’t change anytime soon.

Galen Stops

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