There were several notable highlights in last week's latest BIS Triennial Central Bank Survey, a report published every three years since 1986, of which perhaps the key finding is that trading in FX markets has dropped notably, averaging $5.1 trillion a day in April of this year, down from $5.4 trillion three years ago, while spot volumes fell 17% to $1.7 trillion from $2 trillion, the first time it has fallen since 2001.
This was the first time global currency trading volumes dropped since 2001, a further sign that banks and hedge funds have cut their international activities as tighter regulations and higher risk-aversion begin to bite, the WSJ reported. The drop happened in the spot market, where investors buy and sell currencies outright: Volumes fell 19% to a daily average of $1.7 trillion.
While a part of the fall was due to the rise in value of the U.S. dollar, in which figures are calculated -at constant exchange rates, trading actually ticked up slightly - the data still shows a pronounced slowdown, a sign that banks and hedge funds have cut their international activities as tighter regulations and higher risk-aversion begin to bite. In global currency markets, this reverses the trend of the last decade and a half. Until three years ago, electronic platforms and algorithmic trading had slashed costs and allowed smaller lenders, asset managers and hedge funds to overtake the traditional dominance of large international banks. While these smaller financial firms still make up 51% of daily turnover, inter-dealer trades between global lenders have recovered market share.
"The market has undergone a period of significant change, driven in part by allegations of trader misbehaviour and the subsequent development of a global code of conduct, but also by shifting attitudes within banks to allocate capital as efficiently as possible in light of ongoing regulatory constraints," said David Mechner, chief executive at multi-asset algorithmic trading firm Pragma Securities.
Furthermore, with central banks increasingly encroaching on FX trading, leading to such bursts of volatility as the Swiss Franc reval and the Yuan devaluation of 2015, traders are increasingly leery of being stopped out by some irrational central planner.
According to the WSJ, smaller banks were especially active in reducing their exposure to foreign currencies, BIS figures suggest, adding to the evidence that many lenders have cut back on their cross-border exposure after the financial crisis, due to stricter regulation and international borrowers being hampered by a fall in commodity prices.
However, as JPM points out, what was more striking in the BIS survey was the shrinkage in FX trading by hedge funds and proprietary trading firms which fell by more than 30% over the past three years. The shrinkage in the share of FX trading by these investors is likely the result of regulatory pressures and FX rigging investigations which caused significant retrenchment by FX prop desks. In tota, hedge funds also retreated across a gamut of foreign-exchange products and now make up 8% of daily turnover, compared with 11% three years ago, the BIS said.
JPM adds that less trading by prop desks and hedge funds reduced one important source of market liquidity and is likely behind the decline in FX market depth over the past three years.
On the other hand, global banks may be reaping the rewards of their role as key middle-men in foreign exchange swaps, a market which is bigger than the spot one and keeps growing in importance. Trading in these instruments, which allow investors to hedge currency risk when purchasing assets abroad, increased to a record-high $2.4 trillion from $2.2 trillion three years before. The rise was driven in large part by increased trading of swaps involving the Japanese yen, a testament of how Japanese investors have scrambled to escape punishingly-negative yields in their country by flocking into foreign assets and then striping out the currency risk. The announcement of ultraloose monetary policy in Japan three years ago also led to a surge in the over-the-counter currency options market, which has now cooled again--trading volumes have dropped nearly a quarter since, to $254 billion in April of this year.
Additionally, the BIS broke down the most dominant currencies in the following chart, where as expected the dollar remained supreme. The U.S. dollar maintains its dominant position, representing one side of 88% of all trades in April 2016.
The dollar's gain has been other DM currencies' loss: the yen, the euro and the Swiss franc have lost strength in the global scene after years of easy central-bank policy. In particular, the market share of the common currency has been on a tailspin: In April 2016, the euro was involved in 31% of trades, compared with 39% in April 2010, a steady fall since the sovereign debt crisis kicked off.
Alternatively, the currencies of developing nations have been on the rise over the last three years and as of the latest survey, the Chinese renminbi is now the most actively-traded emerging-market currency. According to BIS, it doubled its daily turnover to $202 billion from $120 billion in April 2013, bringing its global share of trading to 4% from 2%. "With demand for the offshore renminbi set to continue growing, it became clear to us that trading the renminbi in an environment of genuine interest," said Dan Marcus, chief executive of ParFX,a wholesale trading platform.
Some other highlights via JPM:
- The shrinkage in the share of FX trading by fast money investors is likely the result of regulatory pressures and FX rigging investigations which caused significant retrenchment by FX prop desks. At the same time, unexpected events such as the SNB abandoning its currency ceiling and the inability of hedge funds to benefit enough from the big FX themes of the past three years likely caused retrenchment in the FX activity by hedge funds. In all, less trading by prop desks and hedge funds reduced one important source of market liquidity and is likely behind the decline in FX market depth over the past three years.
- What about other markets? With the exception of corporate bonds, the picture is similar in other markets, i.e. the value of trading has been either unchanged or drifted lower over the past few years. In particular, the value of DM equity trading peaked in 2011 at $5.1tr per month and has been stagnant since then, despite the 50% increase in equity prices since then. The value of EM equity trading (ex China/HK) peaked at $640bn per month in 2011 and has declined to only $500bn per month this year.
- The value of trading in UST cash bonds peaked in 2011 also, at $12.4tr, and has been drifting lower since then, averaging $10.7tr month YTD. But this decline masks a shift towards futures trading. Adding trading in UST futures to that of cash bonds, shows only a modest decline from the 2011 peak of $20tr per month (UST cash bonds+futures). Trading in USD Interest Rate Swaps has been relative steady at $1.7tr per month.
- The value of Bund trading peaked in 2011 also, at €5.5tr per month. It has been drifting lower since then, averaging €4.5tr per month YTD. The value of JGB trading was boosted during 2015 and early 2016 as the BoJ cut its policy rate to negative, but trading volumes reverted to historical averages since then.
- The value of trading in Oil and Gold futures peaked in 2011 also. It has been halved for Oil since then, to $1.5tr per month, but declined only modestly for Gold. Similar to Gold, trading in Copper futures has been in a range in recent years at close to $500bn per month.
- In contrast to the dollar value of trading in equities, government bonds and commodities, the dollar value of corporate bond trading continues to reach new highs. YTD, US secondary trading averaged $330bn per month for HG and $180bn per month for HY, boosted by healthy primary markets. Admittedly this rise in the value of corporate bond trading has been taking place amid declining turnover, i.e. trading volumes divided by amount outstanding have been actually unchanged or declining. This suggests that market liquidity challenges remain in corporate bond markets given their overreliance on primary market issuance. Equity market trading is instead far less reliant on primary issuance. YTD IPOs are tracking a $150bn per annum pace, almost half of that of previous two years. But despite this, the value of secondary trading in equities has been little changed