FX volumes: BIS reports an ‘unprecedented rise’ in volumes

Although the figures presented in the latest Bank for International Settlements Triennial Central Bank Survey 2007 will not have come as too much as a shock to foreign exchange market participants, they remain impressive. According to BIS, they show an "unprecedented rise in activity in traditional foreign exchange markets compared to 2004".

Overall daily activity in the FX market rose by 71% at current exchange rates to $3.2 trillion in April 2007 (see table). More impressive, perhaps, was the fact that daily swap volumes rose by 82% to just over $1.7 trillion, and over-the-counter option volumes expanded by almost the same percentage (81%), to $212 billion.

BIS attributes the growth to several factors, including new participants, such as hedge funds and retail, the increase of prime brokerage and diversification into FX by institutional investors. It also points to the increase in automated trading and activity in emerging market currencies.

Albert Maasland, global head of business development e-commerce at Standard Chartered, believes there are three key factors behind the increased popularity of emerging market currencies. "The first is the increase in cross-border trade flows, particularly with the emergence of significant new trade corridors, such as between Asia and Africa, Asia and the Middle East and Asia and Latin America," he says.

Big role

He adds: "E-commerce has also played a huge role by bringing new levels of automation and efficiency, which has helped sustain and create new volume growth. Spreads have compressed, but this has helped attract a whole new range of investor participants, including retail, which is probably now accounting for more than 10% of the spot market. Thirdly, carry trading has increased the interest in trading traditionally less liquid currencies with higher relative interest rates which is linked into the two other factors. Investors not only want to invest in assets in emerging markets with potentially much higher growth rates but also to benefit from interest rate differentials."

The BIS survey will raise questions about whether the market can keep expanding at the same rate. The available evidence suggests that it has the capacity to do so; if the survey had covered August, rather than April, average daily volumes are likely to have been close to a staggering $5 trillion. Ian O’Flaherty, global head of FX e-commerce at Deutsche Bank, is one who believes the market has not yet reached its ceiling. "Over the last three years, electronic trading has helped to encourage a new range of participants to look at FX as an asset class," he says. "It’s transparent and there’s good liquidity. Only four years ago, there were far fewer systems out there. The technology now means there’s a lot of choice in how you connect to the market. The development of APIs is probably one of the most significant things to happen in the market."

O’Flaherty believes that the way the market coped with the spike in volumes in August is proof that it has the capacity to cope. "August has to be considered as an outlier month, at least for the moment," he says. "But even stripping that out, there was still strong underlying growth, which is very encouraging. The number of tickets that went through was almost incredible; barring a few reported hitches, the market and its infrastructure coped well. There are still challenges, banks are looking at the robustness of their systems and planning for more growth. I think we’ll see this, as in FX there’s always a price, even when the market is volatile, which gives participants confidence."

Sean Comer, FX chief operating officer at Barclays Capital, agrees that the market can keep expanding. "I think the growth is sustainable," he says. "The thing with surveys is that they only show a snapshot of the market, and the interesting thing is that April was actually a quiet month. It was almost as much of an outlier as August, which was exceptionally busy. If you look at the six-month data provided by the central banks, the growth is still there. The market has headroom to expand further and although the headline growth rate is huge, when it is spread out over three years it looks more sustainable."

Growth rates

Rob Close, chief executive of CLS Bank, says that activity has continued to rise since BIS polled the market. "Since April we have seen CLS volume and value grow significantly," he says, pointing out that the settlement service has seen a 53% increase in average daily volume of instructions submitted in September compared with April and a 27% increase in average daily value.

Close adds: "I believe we will see continued and strong growth, although volatility will impact the extent. Our members tell us that they are expecting growth in the region of 5% to 7%, and the market is expecting around 20% for platform-based trading. If we continue to see the volatility experienced over the last month or so, these growth figures could potentially be doubled.

"The market has faced challenges over the last few weeks in the light of heightened volumes; however the market, including CLS, has coped well with systems and processes working well. CLS, along with other market participants, will continue to plan with these higher volumes in mind."