December 2016 BIS Quarterly Review: Delving deeply into currency and derivatives markets
11 December 2016
Trading on global currency and over-the-counter (OTC) derivatives markets continues to grow, but why are some segments thriving while others fall back?
The December 2016 issue of the BIS Quarterly Review examines the data collected earlier this year from close to 1,300 banks and other dealers in 52 jurisdictions as part of the Triennial Central Bank Survey of foreign exchange and OTC derivatives markets, the most comprehensive snapshot of the size and structure of these markets.
Three underlying themes emerge, said Hyun Song Shin, Economic Adviser and Head of Research: changes in the role and composition of market participants, the evolving role of emerging market economy (EME) currencies and monetary policy as a driver of market developments. These developments can in turn have an impact on the real economy. "What happens in financial markets does not always stay in financial markets," Mr Shin said.
The December BIS Quarterly Review also:
Finds that the increase in global bond yields over the last few months has not caused major disruption in financial markets. Equity markets rallied and yields rose further as markets priced in a greater likelihood of fiscal expansion after the US presidential election. However, EME assets came under pressure.
"Developments during this quarter stand out for one reason: for once, central banks took a back seat," said Claudio Borio, Head of the Monetary and Economic Department. "It is as if market participants, for once, had taken the lead in anticipating and charting the future, breaking free from their dependence on central banks' every word and deed."
Presents new data from China and Russia, which have started to contribute to the BIS locational banking statistics. The new data show that banks in China are the 10th largest lenders in the international banking market and banks in Russia the 23rd largest.
Finds that differences in the regulations applying to different classes of derivatives partly explain why central clearing has become more entrenched in OTC interest rate derivatives markets than in other OTC markets.
Documents the increased use of the Chinese renminbi in financial trading. The shares of FX derivatives trading compared with spot trading, and of financial counterparties compared with non-financial counterparties, are approaching those of well established liquid currencies. The market for renminbi-denominated interest rate derivatives, however, remains small.
Five special features analyse currency and financial market developments:
Michael Moore (Warwick Business School), Andreas Schrimpf (BIS) and Vladyslav Sushko (BIS)* find that the downsizing of FX markets reflects a fall in the activity of "fast money" traders and hedge funds, and a drop in FX prime brokerage. In contrast, more long-term investors are hedging currency risk, supporting trading in FX derivatives. FX dealer banks are less willing to take on risk, and competition from non-bank market-makers has risen.
Torsten Ehlers and Egemen Eren (BIS)* argue that changing monetary policy stances helped drive a near doubling in the turnover of US dollar OTC interest rate derivatives, while euro-denominated contracts nearly halved. Exchange-traded markets continue to handle the majority of interest rate derivatives turnover, but are growing more slowly than OTC markets. Regulatory reforms have encouraged a move to central clearing and electronic trading and made OTC markets more similar to exchanges.
Christian Upper and Marcos Valli (BIS)* explore why derivatives markets for EME currencies and interest rates are smaller than their advanced economy counterparts. They argue that lower levels of financial development, less integration in the global economy and lower per capita income may be holding back growth in these markets.
Robert McCauley and Chang Shu (BIS)* explain that the rise of non-deliverable forwards (NDFs), contracts which allow hedging and speculation in a currency without providing or requiring settlement in it, masks significant differences across currencies, reflecting different paths of FX market development. While the internationalisation of China's renminbi has favoured deliverable forwards over NDFs, such contracts have become more popular in the Brazilian real and Korean won.
Jonathan Kearns and Nikhil Patel (BIS)* use trade-weighted exchange rates and BIS-constructed debt-weighted exchange rates to assess competing forces influencing the impact that currency moves have on an economy. They find that exchange rate devaluation could damage rather than stimulate activity in emerging market economies where borrowers have a high share of foreign currency debt, probably because of the impact on their balance sheets.
* Signed articles reflect the views of the authors and not necessarily those of the BIS.