Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2004

The 2004 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity - final results of which the BIS is publishing today - shows a substantial increase in turnover in the foreign exchange market and in the growth of activity in the derivatives market. In traditional foreign exchange markets, average daily turnover in April 2004 was $1.9 trillion, a 57% increase at current exchange rates and a 36% rise at constant exchange rates compared to April 2001. This more than reversed the fall in global trading volumes between 1998 and 2001. Turnover rose across instruments but particularly in the spot and forward markets.

In the derivatives market, global daily turnover in foreign exchange and interest rate related products, including outright forwards and foreign exchange swaps, increased by an estimated 74% between April 2001 and April 2004 (51% at constant exchange rates), to $2.4 trillion. Activity grew for both interest rate related and currency-related products. Business was strong especially between reporting banks and main financial institutions, mostly hedge funds and insurance companies, but also between reporting banks and firms. Notional amounts rose by 121% to $221 trillion as of end-June 2004, with a peak in credit-linked contracts, up 568%. Gross market values more than doubled, from $3.0 trillion to $6.4 trillion, in the three years to end-June 2004. However, they fell as a share of outstanding products. After controlling for legally enforceable bilateral netting and other risk-reducing arrangements, credit exposure dropped to $1.5 trillion.

The 2004 survey

In April and June 2004, 52 central banks and monetary authorities collected data for April 2004 on turnover in traditional foreign exchange markets - those for spot transactions, outright forwards and foreign exchange swaps - and in over-the-counter (OTC) currency and interest rate derivatives. Preliminary results on turnover were published in September 2004 and an analysis of the results for the traditional foreign exchange markets was included in the December 2004 issue of the BIS Quarterly Review. The survey also covered data on amounts outstanding of OTC foreign exchange, interest rate, equity, commodity and credit derivatives, which were collected at end-June 2004. This was the sixth global survey since April 1989 of foreign exchange market activity and the fourth survey since March/April 1995 also covering OTC derivatives market activity.

Foreign exchange market turnover

The April 2004 data on turnover in traditional foreign exchange markets highlight several important changes that have occurred in these markets since the last survey was conducted in April 2001.

Activity in traditional foreign exchange markets increased substantially between 2001 and 2004. Average daily turnover rose to $1.9 trillion in April 2004, a 57% increase at current exchange rates and a 36% rise when volumes are measured at constant exchange rates. This more than reversed the fall in global trading volumes between 1998 and 2001. Turnover rose across instruments but particularly in the spot and forward markets.

In addition to valuation effects, factors that have arguably boosted turnover include investors’ interest in foreign exchange as an alternative asset class to equity and fixed income, the more active role of asset managers and the growing importance of hedge funds.

The growth in turnover was driven by all types of counterparties. Trading between banks and financial customers rose most strongly, and its share in total turnover went up from 28% to 33%. Market commentary suggests that this reflected to a large extent the combination of a sizeable increase in activity on the part of hedge funds and commodity trading advisers and robust growth of trading by asset managers. This is in contrast with the period between 1998 and 2001, when activity in this market segment had been driven mainly by asset managers, while the role of hedge funds had reportedly declined. Trading between reporting dealers also rose between 2001 and 2004, although its share continued to fall, from 59% in 2001 to 53% in 2004. Restraining factors might include the continuing consolidation in the banking industry, as well as efficiency gains derived from the use of electronic brokers in the spot interbank market. For its part, the share of trading between banks and non-financial customers edged up to 14%.

Between 2001 and 2004, there were no substantial changes in the currency composition of turnover. The dollar was on one side of 89% of all transactions, followed by the euro (37%), the yen (20%) and the pound sterling (17%). Dollar/euro continued to be by far the most traded currency pair in April 2004, with 28% of global turnover, followed by dollar/yen with 17% and dollar/sterling with 14%. The share of trading in local currencies in emerging markets increased slightly, from 4.5% to 5.2%.

The data for 2004 reveal in most countries a further decline in the number of reporting banks accounting for 75% of the market. This is consistent with the broad trend towards consolidation in the banking industry and the consequent reduction in the number of trading desks. While this has had a dampening effect on global turnover, it has been counterbalanced by other factors mentioned above.

The geographical distribution of foreign exchange trading did not change noticeably in the 2001-04 period. The United Kingdom continued to be the most active trading centre, accounting for 31% of total turnover, followed by the United States (19%), Japan (8%), Singapore (5%), Germany (5%), Hong Kong SAR (4%), Australia (3%) and Switzerland (3%).

OTC derivatives market activity

Turnover data

Global daily turnover in foreign exchange and interest rate derivatives contracts, including traditional instruments such as outright forwards and foreign exchange swaps, rose by an estimated 74%, to $2.4 trillion, between April 2001 and April 2004. At constant exchange rates the increase is 51%, still considerably higher than the 10% growth recorded in the previous survey.

Daily activity grew in both OTC segments, ie interest rate and currency-related derivatives, up by 110% and 51% to $1,025 billion and $1,292 billion respectively. Over the same period activity in exchange-traded derivatives rose by 114%, to $4.7 trillion. Given that exchange-traded derivatives are composed, for the vast majority, of interest rate related products, the expansion recorded in the two markets, OTC and exchanges, has been comparable.

The growth of business in exchange rate derivatives parallels the 57% expansion in turnover in traditional foreign exchange markets. Higher demand in both the traditional and derivatives segments reflects the greater role of such products as an alternative investment class to equity and fixed income products, as well as the larger role of hedge funds and asset managers. In the interest rate segment, changes in hedging and trading practices in the US market helped boost activity. Business in interest rate derivatives may also have been favoured by an exceptional rise in volatility, especially in the US market.

Trading increased at especially high rates between reporting banks and other financial institutions, mainly hedge funds and insurance companies. Expansion was also strong for activity with non-financial customers, ie firms. London and New York remain the two largest marketplaces.

Notional amounts and gross market values

Notional amounts, ie the sum of the nominal absolute value of all deals concluded and still open at end-June 2004, rose by 121% to $221 trillion. As to turnover, the recent expansion in notional amounts by far exceeds the 38% recorded between end-April 1998 and end-April 2001. Across risk categories, activity in interest rate products was higher than that in foreign exchange products, and it was remarkably high for credit-linked contracts, up 568%.

The maturity structure of notional amounts extended. However, business was solid in all maturity segments. Hence exchange rate derivatives remained, as in June 2001, concentrated in short maturities, with more than three quarters of such products having a maturity lower than one year (against just over one third for interest rate products).

Gross market values, the sum of the absolute costs which a party would face if all open contracts had to be replaced at a given reference date and prevailing market conditions, more than doubled between end-June 2001 and end-June 2004, from $3.0 trillion to $6.4 trillion. The ratio of gross market values to outstanding products decreased slightly to 2.9%, from 3.1% at end-June 2001. Controlling for the presence of legally enforceable bilateral netting and other risk-reducing arrangements brings the credit exposure of reporting institutions to $1.5 trillion.

Structure of the report

The survey report is in five parts. Part A is a summary which provides an overview of the main findings. Part B discusses in detail the results for the foreign exchange market. In this part consideration is given only to turnover in traditional foreign exchange market instruments, ie spot transactions, outright forwards and foreign exchange swaps, consistent with earlier BIS surveys of foreign exchange market activity. The results for turnover, notional amounts outstanding and market values of derivative instruments are covered in Part C. Part D contains a full description of the methodology, explaining definitions, classification principles and compilation procedures. Part E is a statistical annex containing tables with the detailed survey results.