Global Foreign Exchange Trading - The Era Of Free Liquidity

Dramatic growth in trading volumes and a seemingly bottomless well of liquidity are transforming global foreign exchange markets. Worldwide forex trading volume surged 36% from 2006 to 2007 among accounts interviewed by Greenwich Associates for its 2008 Global Foreign Exchange Research Study, continuing a steady run of double-digit annual growth. Banks and investment managers are increasing their presence in FX as they diversify portfolios with international assets, and the market continues to attract new users ranging from hyper-active hedge fund traders to a growing cohort of retail investors. Much of this new business is being facilitated by electronic trading technology, which provides institutional, corporate and retail players alike with instant access to deep pools of liquidity at very low cost. (Note: Electronic foreign exchange trading volumes increased slightly more than 20% last year. For complete analysis of developments in eFX, see the April 2008 Greenwich Report: E-Forex Comes of Age.) "For global FX users, we have entered into an era of something close to free liquidity," says Greenwich Associates consultant Robert Statius-Muller. "Cheap access to liquidity from a broad and growing list of sources is drawing in new participants and encouraging users of all types to trade more, which is further adding to global market liquidity." FX Expansion: No End In Sight Last year's 36% surge brings global foreign exchange trading volumes among accounts interviewed by Greenwich Associates to nearly $100 trillion - a jump that comes atop an increase of nearly 20% in worldwide FX trading volumes from 2005 to 2006 and similar growth the prior year. Growth was strongest last year in the United Kingdom, where FX trading volumes jumped some 69% from 2006 to 2007. Volumes increased by about 37% in the Americas and by more than 25% in Continental Europe. Only in Asia excluding Japan, Australia and New Zealand were trading volumes flat year over year. (Note Greenwich Associates tracks foreign exchange trading volume among end-use customers; volume figures reported in this report exclude inter-bank transactions and volume generated by other sources.) The market's steady growth and resilience over the past several years suggest that global FX trading is experiencing a secular expansion rather than a cyclical upturn. "Although some FX users did report minimal disruptions in foreign exchange trading during the uncertain period in August/September 2007, the foreign exchange market is not likely to experience a crisis of liquidity similar to that now playing out in credit markets," says Greenwich Associates consultant Woody Canaday. Greenwich Associates' research reveals several trends contributing to the growth of global FX: Hedge Funds. Around the world, hedge funds were the biggest driver of growth in FX trading volumes last year. The amount of forex trading volume generated by hedge funds increased some 180% from 2006 to 2007. While hedge funds accounted for just 11% of global volume in 2006, that share jumped to nearly 20% in 2007. Portfolio diversification. FX trading volumes increased by 31% from 2006 to 2007 among investment managers and by 23% among banks, the latter of which account for some 36% of the business worldwide. "Among both groups, an ongoing shift of assets away from the United States and into global and international investments is helping drive the increase in FX trading volumes," says Greenwich Associates consultant Tim Sangston. Algorithmic strategies. The spread and advancement of algorithmic trading strategies is giving an important boost to hedge fund trading volumes. "On a global level, hedge funds are, by far, the leading users of algorithmic trading strategies," says Greenwich Associates consultant Frank Feenstra. Retail trading. Foreign exchange markets continue to attract a growing host of retail traders. In past years, trading volumes from this customer segment were captured mainly by so-called "retail aggregators," whose business has been expanding rapidly. The results of this year's Greenwich Associates research suggest that growth rates for these retail aggregators might be leveling off. One possible reason: The retail business has become so attractive that banks have launched and marketed their own retail trading platforms, which are beginning to siphon business from the established retail aggregators. Globalization of Business. As companies expand businesses across borders and overseas they are taking on higher levels of currency exposure. "Although the dramatic increase in FX trading volumes among professional investors has diminished the importance of corporations in global foreign exchange markets, total foreign exchange trading volume among corporates increased nonetheless by some 12% from 2006 to 2007," says Greenwich Associates consultant Peter D'Amario.