19 December 2007
The 2007 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity Report which the BIS is publishing today shows a substantial increase in turnover in foreign exchange and OTC derivatives markets. Turnover in traditional foreign exchange markets increased by 71% between April 2004 and April 2007 to reach $3.2 trillion. The largest contribution to the increase in aggregate turnover was made by growth in FX swaps. Activity in OTC derivatives markets was vibrant in April 2007. Average daily turnover in OTC foreign exchange and interest rate contracts went up by 74% relative to the previous survey in 2004, to reach $4.2 trillion in April. Notional amounts outstanding went up by 135% to $516 trillion at the end of June 2007 and gross market values of OTC derivatives, which refer to the cost of replacing all open contracts at the prevailing market prices, increased at a considerably lower rate (74%) than notional amounts during the reporting period, to $11 trillion at the end of June.
The 2007 survey
In 2007, central banks and monetary authorities from 54 countries and jurisdictions collected data for April 2007 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 2007 and an analysis of the results for the traditional foreign exchange markets was included in the December 2007 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 at end-June 2007. Specific data on credit default swaps was collected for the first time in 2007. This was the seventh global survey since April 1989 of foreign exchange market activity and the fifth survey since March/April 1995 also covering OTC derivatives market activity.
Foreign exchange market turnover
The April 2007 data on turnover in traditional foreign exchange markets highlight several important features of the evolution of these markets. First, average daily turnover has grown by an unprecedented 71% since April 2004, to $3.2 trillion. This increase was much stronger than the one observed between 2001 and 2004. Even abstracting from the valuation effects arising from exchange rate movements, average daily turnover rose by 65%.
Second, growth in turnover was broad-based across instruments. More than half of the increase in turnover can be accounted for by the growth in foreign exchange swaps, which rose 82% compared with 44% over the previous three-year period. Changes in hedging activity may have been one factor underlying the increasing importance of foreign exchange swap instruments. Growth in the turnover of outright forward contracts also picked up significantly to 74%. In contrast, turnover in spot markets increased by 62%, which is roughly unchanged from growth in turnover in the previous three-year period.
Third, the composition of turnover by counterparty changed substantially. Transactions between reporting dealers and non-reporting financial institutions, such as hedge funds, mutual funds, pension funds and insurance companies, more than doubled between April 2004 and April 2007 and contributed more than half of the increase in aggregate turnover. Factors underlying the strength of this segment include strong investor activity in an environment of trending exchange rates and low levels of financial market volatility, a trend shift among institutional investors with a longer-term investment horizon towards holding more internationally diversified portfolios and a marked increase in the levels of technical trading. Turnover between reporting dealers and non-financial customers also more than doubled. Consequently, the share of turnover resulting from transactions between reporting dealers, ie the interbank market, fell to 43%, despite growth in this segment being somewhat higher compared with the previous three-year period.
Fourth, the currency composition of turnover has become more diversified over the past three years. The share of the four largest currencies fell, although the US dollar/euro continued to be the most traded currency pair. The most notable increases in share were for the Australian and New Zealand dollars, which have attracted attention from investors as high-yielding currencies, and the Hong Kong dollar, which has benefited from being associated with the economic expansion of China. More broadly, the share of emerging market currencies in total turnover has increased, to almost 20% in April 2007 from less than 15% in April 2004.
Finally, the geographical distribution of foreign exchange trading did not change significantly. Among countries with major financial centres, Singapore, Switzerland and the United Kingdom gained market share, while the shares of Japan and the United States dropped. In some cases, changing shares reflected the relocation of desks.
OTC derivatives market turnover
Activity in OTC derivatives markets was vibrant in April 2007. Average daily turnover in OTC foreign exchange and interest rate contracts went up by 74% relative to the previous survey in 2004, to reach $4,198 billion in April 2007. This corresponds to an annual compound rate of growth of 20%, which is higher than the 14% growth recorded since the derivatives part of triennial survey was started in 1995. Activity in foreign exchange derivatives rose by 79%, slightly above the rate of increase reported for the spot market (62%). More moderate growth was recorded in the interest rate segment, where turnover went up by 64%.
OTC derivatives notional amounts and gross market values
Positions in OTC derivatives grew at an even more rapid pace than turnover. Notional amounts outstanding went up by 135% to $516 trillion at the end of June 2007. This corresponds to an annualised compound rate of growth of 33%, which is higher than the approximately 25% average annual rate of increase since the current format of the triennial survey was established in 1998.
Growth accelerated in all risk categories. The highest rate of increase was reported in the credit segment of the OTC derivatives market, where positions expanded to $51 trillion, from under $5 trillion in the 2004 survey. Notional amounts outstanding of commodity derivatives rose more than sixfold to $8 trillion, although this may reflect a change in the degree of underreporting as well as a genuine increase in positions. Less extreme, but still high rates of growth were reported for the more traditional types of risk traded on the OTC derivatives market. Open positions in interest rate contracts increased by 119% to $389 trillion, and those in equity contracts by 111% to $11 trillion. Growth in notional amounts outstanding of OTC foreign exchange derivatives was less brisk at 83%, taking the volume of open positions in such contracts to $58 trillion.
Notional amounts outstanding provide useful information on the structure of the OTC derivatives market but should not be interpreted as a measure of the riskiness of these positions. While a single comprehensive measure of risk does not exist, a useful concept is the cost of replacing all open contracts at the prevailing market prices. This measure, called gross market value, increased at a considerably lower rate (74%) than notional amounts during the reporting period, to $11 trillion at the end of June.
Discrepancies between growth in notional amounts and in gross market values have also been recorded in previous surveys. As a consequence, the ratio of market values to notional amounts fell to 2.2%, from 3.1% in 2001. One reason why the replacement values of derivatives positions increased at a lower rate than face values is that long-term government bond yields in the major currencies, which are the main driver of the market value of interest rate swaps, on balance changed by only very small amounts between mid-2004 and mid-2007. Since interest rate swaps, similar to most other derivatives contracts other than options, tend to be priced such that their initial value is zero, stable long-term rates are usually associated with low replacement values. Implied volatilities, an important input for the market value of options, also remained stable at a low level between the 2004 and the 2007 surveys. By contrast, stock prices rose sharply in most regions, which is consistent with the fact that the replacement value of equity contracts increased at a much faster rate (278%) than notional amounts (111%).
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.