The foreign exchange market is unique in one respect in that it is unlike any regulated national exchange, where transparency is apparent for all transactions. The forex market, on the other hand, has always been a broad based over-the-counter (OTC) networked system that relies upon credit relationships. As such, it is often difficult to get a good read on total activity, other than from anecdotal reports by various banks and brokers. The exception is the Bank for International Settlements (BIS) triennial survey. There is good news in the 2019 survey – Spot, forwards, and options trading are up 30%.
In the absence of this all encompassing survey, it would have been easy to reach incorrect conclusions about volume related data over the past few years, due in part to a process described as “internalization”. We recently reported:
A new report cites low volatility as reason that large banks in the Interbank system are “internalizing” more of their customer client capital flows on their own platforms. These efficiencies have actually reduced volume to $368 billion per day in 2019, a 7% drop from similar volumes in 2016.
The latest BIS report, entitled “Sizing up global foreign exchange markets”, speaks to this issue, as well. Andreas Schrimpf and Vladyslav Sushko of the BIS noted to reporters from Forbes:
In recent years, changes in market structure, such as the internalisation of trades in dealers’ proprietary liquidity pools, further reduced the share of trading activity that is “visible” to other market participants. The Triennial Survey provides a comprehensive, albeit infrequent, snapshot of activity in this highly fragmented market.
The diagram above, provided within the BIS report, clearly shows a healthy increase in volumes from the previous survey date in 2016. Yes, the shares of “Reporting dealers” and “Non-financial customers” have declined, ostensibly due to “internalization”, but the total daily turnover now stands at $6.6 trillion per day. The report also notes the disparate difference between this figure and $100 billion per day, a rough guesstimate of global exports of good s and services. Hedging and speculation account for the “gap”.
The report also confirms that the global market for derivatives is also growing leaps and bounds. When the financial crisis hit in 2009, market observers had predicted the collapse of the derivatives market, presuming that it would buckle under the weight of new rules, regulations, and standards enacted in the aftermath. On the contrary, the entire forex market has expanded greatly due to “the growing economy in the U.S., chasing higher returns because of a very low interest rate environment, the increase of non-banks in derivatives markets, and the advent of electronic and automated trading”.
Additional reported items worthy of note:
- “In 2019, the BIS’ foreign exchange and interest rate derivative data comes from almost 1,300 dealers, mainly banks, located in 53 countries.”
- “London, New York, Singapore and Hong Kong SAR increased their collective share of foreign exchange global trading to 75% in April 2019, up from 71% in 2016 and 65% in 2010.”
- “The largest global dealers in the world are banks like Bank of America, Citibank, Deutsche Bank, Goldman Sachs, JPMorgan, and Morgan Stanley, and Inter-dealer trading accounts for 47% of all foreign exchange swap turnover.”
- “BIS data shows that the share of emerging market currencies in global foreign exchange turnover rose to 23% in April 2019 in comparison with 19% in 2016 and 15% in 2013.”
The report concludes with a general warning that these “notional” figures do not speak to the issue of risk, especially in the derivatives arena. Enhanced risk management oversight is fast becoming a pressing need in the world of derivatives and the risk they present. Systems and professionals must improve upon current methods in order to “identify, measure, control, and monitor the counterparty, market, and liquidity risks of these instruments 24/7, especially at internationally active companies and financial institutions”.
The track record to date, however, has not been a very good one:
Unfortunately, we have plenty of financial institutions such as Allied Irish, Barings, Bear Sterns, Daiwa, JPMorgan, Lehman, Société Générale, and UBS, which have suffered significant financial losses, and in some cases, imploded when risk management around derivatives trading failed spectacularly.