Global foreign exchange volumes increased 17% from 2005 to 2006, according to new research from Greenwich Associates.
Foreign exchange trading volume among the more than 1,600 large companies and financial institutions participating in Greenwich Associates’ annual FX research grew to US$70.6 trillion in 2006.
In addition, interest-rate derivatives trading volume reported by the 694 companies and institutions interviewed by Greenwich in that market increased to US$1.4 trillion in 2006, representing a recovery from a year of stagnant trading volumes with a 10% increase 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.
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, it noted. 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.”
Meanwhile, it also found that retail investors are a growing source of FX trading business. 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. And, 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, Greenwich said.
The firm cautioned that 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.”
Also, Greenwich said that half of global buy-side foreign exchange trading volumes were executed electronically in 2006. “The increase in electronic trading activity over the past 12 months has been nothing short of remarkable,” says 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 Greenwich’s 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.”
Finally, Greenwich indicated that, after a 12-month period in which interest-rate derivatives trading volumes failed to grow, they 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, it said. Large swaps trades on the back of debt issued by companies for the financing of M&A transactions also helped derivatives activity recover, it added. In the U.S., 45% of companies that used derivatives or strategic purposes did so in relation to M&A transactions.