Since the financial crisis, both FX and money markets have undergone significant changes, driven primarily by increased self-regulation and the introduction of broad-ranging regulatory changes on both sides of the Atlantic. Peter Zöllner, the Head of the BIS Banking Department, has been keeping a close eye on these changes, and took the opportunity during the March 29, 2014 ACI Financial Markets World Congress 2014 in Berlin to update his audience on some of the major recent trends in the FX and money markets.
Starting with FX markets, the chief trend Zöllner sees is an all-time high in FX turnover. According to Zöllner, the BIS’s 2013 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity reveals that “FX turnover reached an all-time high of $5.3 trillion per day in April 2013, up by 35% relative to 2010. This was faster than the 20% rise from 2007 to 2010, but fell short of the strong increase in the pre-crisis period from 2004 to 2007.”
We estimate that the $5.3 trillion per day reported in the survey month of April 2013 was a peak, indeed perhaps the most active period of FX trading ever recorded, so it is important to bear this in mind when considering the findings of the Triennial. Activity subsequently fell by $300 billion to $5 trillion per day in October. The decrease was primarily driven by a drop in spot transactions involving mainly euros and yen against the US dollar. The decline in euro trading extends a trend that began in the third quarter of 2011, while the fall in yen trading reflects a partial reversal of a sharp rise that occurred in late 2012 and early 2013. Anecdotal evidence points to an increase in FX turnover towards the end of 2013.
Mr. Zöllner attributes this massive increase in FX turnover to market, structural, and technological changes in the FX space:
- One reason behind this increase in turnover was the intensive trading of yen pairs following the Bank of Japan's monetary policy regime shift in early April 2013, which triggered a phase of exceptionally high turnover across asset classes. In the months that followed, particularly during the summer, the rise in yen trading partly reversed. Even without this yen effect, however, FX turnover would probably still have grown by about 25%.
- Another reason for the higher turnover is the growth of investment in international assets. With yields in advanced economies at record lows, investors increasingly diversified into riskier assets such as international equities and local currency emerging market bonds. Over the past three years, equities have provided investors with attractive returns, emerging market bond spreads have simultaneously dropped, and issuance in riskier bond market segments (eg local currency emerging market bonds) has soared. Not only did these three factors give rise to the need to trade FX in large quantities and to rebalance portfolios more frequently, but it also went hand in hand with greater demand for hedging currency exposures. This triggered currency trading as a by-product of investments.
- A third reason is greater participation by non-dealer financial institutions. FX markets have traditionally been dominated by inter-dealer trading. However, transactions with non-dealer financial counterparties grew by 48% to $2.8 trillion per day in 2013, up from $1.9 trillion in 2010, and accounted for roughly two thirds of the rise in total turnover during the period. I will explore the reasons for this shift in FX trading from dealers to non-dealer financials in greater detail in the next section.
- Related to 3 above, a number of technological advances (which I will also discuss at more length in what follows) have also contributed to the growth in FX volumes in recent years. These include the emergence of liquidity aggregators and algorithmic trading techniques.
In the money market space, Mr. Zöllner notes two noticeable trends over the past quarter: an increase in secured funding, and some changes in the composition of the repo market with the share of directly negotiated repos increasing at the expense of electronically traded repos. Zöllner also notes that repo trading through CCPs has increased and there have been some changes in collateral composition.
Some major trends Zöllner notes affecting both the FX and money markets are the rise of centralized clearing in both areas along with its attendant increase in transparency. He also notes an evolution in collateral management for both areas as a result of increasing use of new technologies for reducing funding costs and counterparty risk.
In addition, Zöllner sees general concerns in both the FX and money market industries in the wake of manipulation of market reference rates by commercial banks. He notes that regulators have increasingly been
focused on reference rate reform, with an aim of restoring credibility and eliminating the risk of manipulation. As their work progresses, Mr. Zöllner expects even more wide-ranging investigations into alleged collusion and rate manipulation around the time that FX rate benchmarks are set.