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BIS Explains FX Volume Growth
Back in September, the Bank of International Settlements announced that daily FX volume reached $4 trillion, a 20% growth from 2007. At the time, they said that the increase in turnover was due largely to the activity of “other financial institutions” which basically meant everyone except for banks dealing in FX and importers/exports (non-financial customers). This category includes everyone from non-reporting banks to hedge funds, central banks, insurance companies, mutual funds, and retail FX brokers. However earlier this week, the BIS released an in depth report explaining what is behind the increase in FX volume over the past 3 years. It is a thorough report that is word a read (BIS report -- Pages 27-40) and here’s a summary of their “official” findings.
The increase in growth is due to:
1. Greater Activity by High Frequency Traders
-- EBS Spot Ai was a key turning point for the algorithmic trading market
-- Introduced in 2005, it gave major institutions access to the inter-dealer market
-- Between 2007 and 2010, its share of trading on EBS grew from 28 to 45%
-- CME also launched an algo platform in 2002 and over the past 3 years, the turnover in FX volume has more than doubled
-- High Freq trading is estimated to account for 25% of spot FX activity
2. More Trading by Smaller Banks
-- Greenwich Associates estimates that more than 50% of total FX volume is conducted electronically
-- The cost effectiveness and increased competition have lowered transaction costs, giving smaller banks and retail investors better access to the market which has in turn increased turnover
3. Emergence of Retail Investors (Pat yourself of the back)
-- BIS estimates that retail investors accounts for 8-10% of spot FX volume ($125-$150B a day)
-- In Japan, retail investors represent 30% or more of spot trading volume
Also, the financial crisis occurred between the 2 survey periods which means that some of the increase in trading volume can also be attributed to the use of spot FX to hedge risk exposures in other markets. For example, it was quite popular to hedge the decline in U.S. stocks with long Japanese Yen exposure.