So the latest Bank for
International Settlements (BIS) Triennial Central Bank Survey is out and, as
Profit & Loss previously reported,
the headline figure is that the FX market has contracted in size from $5.3
trillion to $5.1 trillion traded per day over the past three years.
This news seems to
have caught very few people by surprise.
“We weren’t surprised
by these results because we’ve been witnessing a steady decline in spot
transactions since the last BIS survey. From a platform perspective I would
have been more surprised and concerned if the volumes had gone up, because
we’ve seen our volumes and the volumes of other ECNs deteriorate over the past
three years. But now we can see for certain that this is in line with a broader
trend in the industry,” says Darryl Hooker, co-head of EBS BrokerTec Markets.
A 19% decrease in spot
transactions was the major cause for the overall decline in volumes, and there
are a number of reasons why spot activity has become more muted since 2013.
One reason is simply
that the continued global trend towards low interest rates means that there is
less incentive for firms to trade FX.
“Right now there are
less trading opportunities because interest rates in general are still low and
therefore the appetite to trade one currency versus another predicated on
interest rate differentials is reduced and so overall volumes are down. Does
this concern me? Yes. Do I think it’s about to change? Probably not, because I
think that we’re in an environment where interest rates are likely to remain
low for a relatively long time,” says Paul Chappell, CIO of C-View.
Another reason is that
the Volcker Rule has taken hold, meaning that banks are committing less capital
to risk taking activities than they were previously.
“The decline in the
commitment of capital from major financial institutions in general, which is
being driven by the Volcker Rule, would manifest itself primarily through spot
transactions,” says David Puth, CEO of CLS.
observes: “Over the past three years we’ve seen a significant decline in prop
trading, I’m not sure that it really exists anymore at the banks. That was a
huge part of the market, people were speculating on where currencies and
interest rates were going and they were taking positions as a result, this just
isn’t happening any more.”
Hedge Fund Decline
The decline in FX
trading activity by hedge funds and proprietary trading firms indicated by the
survey is yet another reason for the decrease in spot volumes, according to one
market source. In 2013 these firms accounted for 11% of FX market turnover but
this figure has dropped by 27% over the past three years so that they now
account for only 8% of FX trading activity. The source claims that these type
of firms have traditionally been very active in the spot market and that
therefore the fact that they’re trading less has lead to a broader slowdown in
The root cause of
hedge funds and proprietary trading firms trading less FX is that credit has
become much harder to access, the source says. Giving an example of where this
is having an impact, they point to that fact that trading on EUR/USD has
dropped from accounting for 24.1% of trading activity to 23% over the past
three years. The source says that lots of hedge funds traded EUR/USD based on
leverage and that as credit has become more constrained, trading in this pair –
still the most liquid currency pair traded – has declined accordingly.
This is consistent
with the view expressed by a source at one major bank in London, who highlights
that the leverage firms are being offered has come down across the industry and
adds that some hedge funds have either exited the FX market because of poor
returns or a perceived lack of opportunities, or they have shifted to become
family offices instead.
In addition to this,
more than one source referred to “the whole SNB thing” as an explanation of why
spot volumes have declined. The view expressed by these sources was that the
volatility prompted by the Swiss National Bank’s (SNB) decision to drop its peg
to the euro caused a number of firms to either leave the FX market or reduce their
overall risk exposure. In addition to this, it exacerbated the trend towards a
more credit constrained environment that in turn made it harder for some firms
to access and trade in the FX market.
“Trading was impacted
by extraordinary events during 2015 and early 2016. In particular, the actions
of the SNB in January 2015 materially affected the spot market. Most notable is
the systematic decrease in leverage across the entire ecosystem. This resulted
in a noticeable volume reduction,” says Chris Concannon, CEO of Bats.
The continued fallout
from the recent FX scandals was also mentioned by some sources as a potential
reason for FX market activity declining. For example, Chappell claims that some
investors are steering clear of the asset class because of the negative
connotations caused by these scandals.
“One thing that
requires further resolution is that we still have an industry that is smarting
from the scandals that have occurred within it and have acted as a deterrent
for investors, some of whom aren’t particularly enamoured with currency as an
asset class right now. The sooner the industry is able to show that it had
completely cleaned its act up, the better,” he says.
Another consequence of
these scandals, says Hooker, is that a number of experienced FX professionals
have either left or been removed from their positions and that the market has
lost important expertise as a result. “If you look at the people who have been
removed from the FX business over the past three years, the market has lost
some significant trading participants which haven’t been replaced,” he says.
Taken in the context
of all these challenges, it can be argued that the FX industry has actually
demonstrated strong resilience.
activity was down 5%, the April 2013 survey took place against the backdrop of
heightened trading activity caused by monetary policy developments in Japan,
while in April 2016 the largest multibank platforms all reported a
month-on-month and year-on-year slowdown
in trading activity.
This slowdown could
have been caused, in part, by the fact that many hedge funds were experiencing
large redemptions after the volatility in the first quarter of the year and
therefore trading less. It also highlights the inherent problem with analysing
data that is based on a one month snapshot rather than annual.
In addition to this,
the latest survey highlights the impact that the strengthening of the US dollar
had, as it reduced the USD value of the turnover in other currencies. Indeed,
the survey says that when valued at constant exchange rates, FX market turnover
actually increased by about 4% over the past three years.
“The fact that the BIS
survey shows overall FX volumes are flat on a constant currency basis is
testament to the resilience of the FX market, says Phil Weisberg, global head
of foreign exchange, rates and credit trading at Thomson Reuters. “Over this
period the market has transitioned to higher, more stringent standards due to
both the Volcker rule and the code of conduct which have both had an impact on
“The drop that the
market has seen in spot volumes may be a function of reduced volatility,
increased internalisation, and fewer opportunities for arbitrage as market
efficiency has improved,” he adds.
Likewise, Dan Marcus,
CEO of ParFX, comments: “When the results of the last BIS Triennial Survey were
published in 2013, we were looking at a very different market landscape than we
are today. In the past three years, there has been a significant shift in
market structure, undoubtedly influenced by elements such as black swan events
such as the SNB decision, extended periods of low volatility and interest
rates, and the continued prominence of disruptive latency-led misbehaviour.
“While all of this has
had an impact on trading activity, it also serves to demonstrate one of the FX
market’s best qualities – its ability to continuously adapt and stay relevant
in light of changing market and regulatory conditions,” he adds.
One clear area of
growth for the FX market over the past three years has been the FX swaps
market, where turnover rose by 6% to reach $2.4 trillion per day in April 2016.
Although the BIS attributed this growth to an increase in FX swaps trading
involving the yen, the source at the London bank admits that there is some
confusion amongst the banks about why swaps trading is up.
explains: “I think that the growth in swaps trading is driven by two factors: a
continued increase in cross-border trading by the investor community and a
significant increase in the hedging of FX exposures as companies become more
sophisticated and as they have reacted to the appreciation of the US dollar
that’s taken place.”
says that he is not surprised that the survey shows an increase in FX swaps
flow because “this is flow that has to be executed in the interbank market,
it’s not trading that you can easily internalise and so I think that’s
encouraged further growth in the OTC market”.
The other big area of
growth that has attracted a lot of attention following the publication of the
survey results is that turnover in the RMB grew by 81% from April 2013 to April
The main reason for
this increase, according to Jon Vollemaere, CEO of R5FX, is the amount that the
RMB is used in trade as China’s economy continues to grow.
“I think the growth of
the currency is mainly trade-based, the inclusion of the RMB into the SDR
[Special Drawing Rights] basket was a positive thing but I think that it was
largely political. At the moment the main reason why the currency is growing is
because China is a massive economy and they’re huge buyers and sellers of
everything on the planet,” he says.
Puth, on the other
hand, expressed some surprise that trading in RMB had not increased by more
since the April 2013 survey. With data from Swift in August showing that the
RMB is the fifth
most active currency for global payments by value, Puth says that he
expected an even greater jump in trading in this currency in the BIS results.
In contrast, Kevin
Kimmel, COO, FX, Citadel Securities, says that the
growth of RMB was broadly in line with his expectations. “The report confirmed
what we’ve seen in the marketplace regarding the growth of Asian EM currencies,
particularly the Renminbi, becoming a greater mix of overall volume as Asia
continues to become a larger part of the global economy,” he says.
It is perhaps
interesting that while the Asian EM currencies did well – with the Korean won,
the Indian rupee and the Thai baht all advancing in the BIS rankings by two or
three places – other EM currencies have not performed as strongly.
The South African
rand, the Mexican peso and the Russian ruble all dropped down the rankings, in
the case of RUB by six places, showing that the EM growth story is specifically
an Asia EM growth story.
This Asian EM growth
story also helps explain the increased market share of the Asian financial
centres for FX trading.
The BIS survey results
show that Tokyo, Hong Kong and Singapore intermediated 21% of FX trading, up
from 15% in April 2013. Over the same period of time the share of FX
intermediated in the UK dropped from 41% to 37%, leading to questions about
whether these two statistics are linked and whether the growth of FX trading in
the Asian financial centres was at the expense of the UK.
Market sources were
mixed in their response. A source at one trading firm claims that the two are
not particularly linked but that, as China encourages the liberalisation of its
currency, firms based in Asia will naturally try to take advantage of the
opportunities that present themselves and therefore trading activity will
A senior figure at a
different trading firm says that the two are probably linked “to some degree”,
but that this shift isn’t surprising as Asian economies continue to grow and
therefore form a bigger portion of the overall global transactions taking
place. As Asian currencies become traded more frequently, they will increasing trade
during Asian hours, they say, pointing out that electronification means that
firms can trade anywhere at any time of day and the days of calling a London
voice trader to get a quote are over.
“Could the growth of
FX trading in Asia come at the expense of London? It could well be, because in
the past if you used to send trades to London but now you can execute them
locally,” says Vollemare.
The real issue that
determines where FX trading activity occurs, he adds, is the location of the
customers. Vollemare says that right now customers call London to execute FX
because the liquidity there is good, they can get their order filled and they
already have a relationship there, but notes that if the relationships start to
drift east then so too will trading activity.
A number of sources
actually expressed mild surprise in the drop of the UK’s market share,
including the source at the bank in London, who attributed the shift to more
firms looking to invest in Asia coupled with an aggressive regulatory regime in
Europe and the US that has pushed activity east.
Looking ahead, one of
the biggest factors that might determine whether the UK continues to lose FX
market share is the outcome of the Brexit negotiations. Right now, however,
there is little or no clarity about even the timetable for negotiating
Britain’s exit from the European Union, let alone the terms on which is will
exit, which will obviously have a major impact on the financial services
industry. Should the UK lose access to the single market then it is surely not
inconceivable that the amount of FX trading taking place there could continue
declining as a percentage of the overall FX market.
Overall, the mood from
market participants was cautiously optimistic when considering what the FX
market might look like three years from now.
“I think that we’re
standing on solid ground, from a market infrastructure standpoint, where there
is a greater focus on risk mitigation and on conduct that will help a truly
deep and well functioning market get even stronger,” says Puth.
The source at the bank
in London is also bullish regarding the future of the FX market, noting that
there are a number large macro events that could drive volumes up this year,
that interest rate differentials are likely to return at some point and that
the continued RMB growth is good for the industry overall.
Despite this, there
appears to be an expectation amongst some sources that the market has entered a
“new normal” whereby there will be growth in the FX market size but that it
will not be on the same scale as it was between 2001 and 2013.
“We don’t expect
future volume growth to be as strong as in previous periods due to factors such
as regulations and tighter credit. However, we do think that liquidity
conditions will improve from where they are today as the marketplace adapts,”
The 2016 BIS survey
results appear to have contained few surprises and, given the challenges that
the FX market has faced over the past three years, arguably demonstrate the
resilience and the necessity of this market. Despite the first contraction in
the overall size of the FX market for 15 years there appears to be some
optimism that the market will continue to grow in the future, albeit at a