Agency Broker Hub: The FX factor

Gian Marco Salcioli, Head of Global Markets Strategy at IMI Corporate & Investment Banking Division of Intesa Sanpaolo, explains the global flows of FX markets and the role of the US dollar.

It is common knowledge in foreign exchange (FX) markets that efficiency of pricing equilibrium is one of the key historical features of the post-Bretton Woods system of the 1970s. Following that, the modern FX market emerged as we know it today, featuring the first real globalised financial product and 24-hour trading allowed in all major currencies. One could say also it is the first instance where the evolution of technology has been really revolutionary, making it one of the largest markets, the most liquid, and one where the evolution of structured products and exotic options has driven growth and interest in the market.

This is the biggest over-the-counter (OTC) market, where a big part of the total volumes are not ‘officially’ measured due to the fact they are not placed in a regulated entity (i.e. stock market). So, the question that often arises is: who is measuring the turnover of the FX market, divided by instrument, by counterparty, and by currency bloc and currency pair, and the geographical distribution? And, perhaps most important of all, is the dollar’s dominance coming to an end?

The only global report available: BIS Triennial OTC Foreign Exchange Survey

It may come as a surprise, but there is no global data measuring the above, except this survey conducted by the Bank for International Settlements (BIS), which is prepared every three years. See link here: https://data.bis.org/topics/DER.

In a nutshell, many central banks are monitoring and calculating flows with a geographical bias and a national currency focus, and many players of the financial system (i.e. banks, real money, hedge funds, CTA’s) have their own proprietary models (market making, proprietary and overlay trading, for example) which have no data disclosure protocols – for obvious reasons. Looking at 50 currencies, what are the main takeaways?

FX: despite the ‘de-globalisation’ and reshoring a very fast-growing markets

As is customary, volumes are calculated in one month intervals (in this case, April, then annualised) and the data published a few months later. Trading in the OTC market has reached a record US$7.5 trillion daily turnover, 14% higher compared to three years earlier. Considering this period falls across the pandemic, and wider reshoring and deglobalisation trends, this is a relatively substantial achievement. The fact is, FX is growing no matter what.

Instruments used: this is not an options market

Surprisingly, derivatives (namely, option structures from Vanilla, Asian or Binary, or a combination of the three) are accountable for only 4% of total volumes. Spot deals, typically T+2, stand at 28% while the rest is made up of currency swaps – more than two thirds (68%). Only a small portion of these swaps are a longer tenor and make up only 2% of total turnover. So, FX markets are cash, vanilla, short term markets. Now, let us consider the main active players.

Surprise! Corporate historically low participants. Why?

It is widely known that FX markets consist mainly of cross border conversion on the back of goods and services bought and sold. Although this is a very important part of the turnover, it is only 6% of the total (non-financial customers). The frenetic growth during the last two decades of pure financial assets (bonds, both public and private; equity; and any instrument quoted and negotiable in a non-local currency) has taken the lead. Almost half of the total (48%) is made up of a category called ‘other financial institutions’, the breakdown of which is as follows: non-reporting banks, such as smaller regional banks (22%); institutional investors, (i.e. real money funds), 11%; and hedge funds and proprietary trading firms (7%). The official sector, central banks, make up only 1%. This revelation only confirms the notion that a central bank has a very limited influence over the fate of its national currency. The market is far bigger than any official reserve held in any central bank’s portfolio and any form of open market intervention to support any currency is short lived if not assisted by the volumes generated by market participants.

However, a key point to remember is that the remaining 46% of the total are ‘reporting dealers’, a category made up of players mainly on spots (40%), and through single or multi-bank platforms in a fully automated way, using algos and artificial intelligence modelling. This is creating a direct connection between the main players, without intermediaries, and providing a buffer of liquidity that is enhancing the transparency and the depths of the market. This is why it is more accurate to talk about distribution of flows between time zones instead of physical and geographical places such as stock exchanges.

Dollar dominance dead? Data are suggesting the opposite

Dollar remains the dominant force in global trades: a striking 88% of total deals are done directly or indirectly through the dollar (that’s the reason for multiple percentages). The Euro stands at 30.5%, while JPY is 16.7%, and GBP 12.9%. A big jump in the Chinese currency (CNY), which accounts for a 7% share, reflects its doubling in weight over the past three years. The most traded currency pair is EUR/USD (22.7%), followed by USD/JPY (13.5%) and GBP/USD (9.5%). Fourth place is occupied by USD/CNY.

Regarding geographical distribution, we see a reduced footprint from the United Kingdom (from 43.2% to 38.1%), even if it remains by far the biggest, followed by the United States (19.2%) and Japan(4.4%). If you want to be in the sweet spot for the most liquid market conditions? Early afternoon CET time when the UK (and Europe) are fully active and the USA is just kicking into gear.

Source: 2022 Triennial Central Bank Survey of Foreign Exchange an OTC Derivatives Markets – Bank of International Settlements – https://www.bis.org/statistics/rpfx22.htm

*Market Viewpoints comprise sponsored content and do not necessarily reflect the views of the editor.