Global FX Surge Suggests Sustained Expansion, IR Derivatives Business Marks A Return To Growth
( Greenwich Associates )
(May 15, 2007)
Tuesday, May 15, 2007 Greenwich, CT USA - Global foreign exchange volumes increased 17% from 2005 to 2006, according to new research from Greenwich Associates. At the same time, the interest-rate derivatives business recovered from a year of stagnant trading volumes with a 10% increase in 2006.
Foreign exchange trading volume among the more than 1,600 large companies and financial institutions participating in Greenwich Associates' annual FX research program grew to $70.6 trillion in 2006. In addition, interest-rate derivatives trading volume reported by the 694 companies and institutions interviewed by Greenwich Associates in that market increased to $1.4 trillion in 2006.
"In the foreign exchange market, two trends in particular appear to have boosted trading activity to a new and potentially sustainable level: the increased international investment activity associated with globalization and the increasing use of electronic trading systems," says Greenwich Associates consultant Peter D'Amario.
Research Note: Greenwich Associates tracks foreign exchange and interest-rate derivatives trading volume among the companies and institutions constituting the "buy-side" of these markets. Volume figures in Greenwich Associates research do not include or reflect inter-bank trading volumes.
Foreign Exchange: A Strong and Consistent Expansion
The primary drivers of growth in the FX markets over the 12-month period covered in the Greenwich Associates research were banks, fund managers and other types of financial institutions. Trading volumes among global banks increased 17% from 2005 to 2006, volumes among fund managers/pension funds increased 23% and institutions categorized by Greenwich Associates as "other financials" saw their FX trading volumes soar some 54%. Hedge fund FX trading volume increased more modestly year-to-year. Meanwhile, corporate trading volumes were essentially flat in absolute terms over the past 12 months as corporate business fell to just 16% of total foreign currency trading volume from more than 20% in 2005. "The days in which FX markets served primarily as a venue for corporations looking to hedge currency exposure are gone - at least for the foreseeable future," says Greenwich Associates consultant Woody Canaday. "As financial institutions continue ramping up their currency trading business, corporates are becoming a less significant part of the market."
At the same time, a much different group of traders is growing in importance as a source of FX trading business: retail investors. Many of the companies included in the "other financial" category in the Greenwich Associates research are so-called "retail aggregators," reflecting the growing role of "retail" investors in the FX markets. In addition, some portion of the increase in bank trading volumes - which have been driven primarily by expansions in cross-border trade and investment - can be attributed to margin trading through banks' retail networks and to retail business conducted through private banks in Europe and Asia.
Of course, it is an open question as to whether this new and expanding retail customer base will be part of the global FX market for the long haul. "Retail trading platforms are being advertised on the Internet and on television infomercials in the United States," says Greenwich Associates consultant Tim Sangston. "Maybe these examples are not a sign of a market top, but they do indicate that some of the money flowing into foreign exchange is less than sophisticated and could be fleeting."
E-Trading Systems Capture Half of Global FX Volumes
One half of global buy-side foreign exchange trading volumes was executed electronically in 2006. "The increase in electronic trading activity over the past 12 months has been nothing short of remarkable," says Peter D'Amario. "In 2005, e-trading systems captured less than 30% of global FX trading volumes."
The proportion of global FX users trading currencies electronically increased from 44% in 2005 to 53% in 2006. At the same time, the proportion of FX users stating that they have no plans to ever trade FX electronically dropped to 36% from 43%. "These results suggest an important shift in attitudes toward e-trading," says Frank Feenstra. "For several years, the FX market was essentially evenly split between e-traders and abstainers. This year it seems the tide has turned - users that in the past have spurned e-trading systems are becoming converts."
Interest-Rate Derivatives: A Return to Growth
After a previous 12-month period in which trading business failed to grow, interest-rate derivatives trading volumes increased 10% from 2005 to 2006. Overall, conditions in 2006 were not entirely favorable for the interest-rate derivatives business, but increases in short interest rates in many countries and the resulting uncertainty about future direction led to a pickup in activity. Large swaps trades on the back of debt issued by companies for the financing of M&A transactions also helped derivatives activity recover. In the U.S., 45% of companies that used derivatives or strategic purposes did so in relation to M&A transactions. A dampening of the negative impact that IAS 39 and FAR 133 have on the use of derivatives is another factor contributing to more customer activity. This year, 52% of companies globally say they used non-hedge accounting eligible derivatives - up from 42% last year.
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