Presentation to the Hong Kong Institute for Monetary Research Hong Kong, 19 November 2001

1. The Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity:Results for April 2001 Presentation to the Hong Kong Institute for Monetary Research Hong Kong, 19 November 2001 Robert N. McCauley Deputy Chief Representative Representative Office for Asia and the Pacific Bank for International Settlements

2. Overview I. Overall foreign exchange trading down-why? II. Developments in Asia-Pacific centres and currencies III. Interest rate derivatives still growing smartly. Work with Gabriele Galati, Head, Monetary Policy & Exchange Rates Section, Monetary & Economic Department, BIS

3. Background on survey • 48 central banks participated in April 2001, up from 43 in 1998 • Covers both traditional forex market and over the counter derivatives markets • Forex survey covered 9 currencies in 1998, 28 in 2001; interest rate survey, 9 in 1998, 16 in 2001. • Central banks publish own results, BIS collates & publishes int’l statistics

4. Overall forex trading down

5. I. Overall trading down owing to... • The introduction of the euro. • Electronic trading. • Consolidation of market makers and non-financial customers. • Note that electronic trading, intro of euro and consolidation had already slowed growth of trading in 1995-1998. • But consolidation accelerates 1998-2001.

6. The prospect of the euro: arithmetic versus liquidity • Arithmetic: Euro eliminates transactions among participating currencies, eg. DM/FF, so $ share up. • Liquidity: If euro gained liquidity as compared with the DM, then its use against currencies other than the $, especially the yen, might be boosted significantly, $ share stable, even lower.

7. 2001 survey supports arithmetic view

8. Euro has followed arithmetic, with no quantum jump in liquidity • Dollar/euro share (30%) larger than dollar/mark (20-22%) but smaller than Dollar/EMS (37%). • Euro/yen barely larger than DM/yen vs hopes for surge in this pair. $ still vehicle. • Trading in sterling and SF has shifted toward $, away from DM/euro.

9. Electronic broking • Centralises price discovery • Allows medium-sized banks access to best prices without reciprocal obligation to participate in interbank transactions. • EBS and Reuters accounted for 5% of spot interbank trading in major currencies in 1995, 20-30% in 1998 and 40% in 2001.

10. Electronic trading shrinks spot turnover

11. Electronic broking shrinks interbank spot market

12. Consolidation • Number of participating banks down. • Number of banks accounting for 75% of the business in each reporting centre has fallen sharply.

13. Number of participating banks down • In 26 participating countries: 1,945 in 2001 vs 2,205 in 1998 and 2,417 in 1995. • Centre-by-centre view shows sharp drop off in UK, HK, SG and DE.

14. No. of banks in survey down

15. Concentration up markedly • Merger of UBS & SBC, JP Morgan & Chase or Deutsche & Bankers Trust allows customer orders to offset each other, leaving less to be traded in market. • Conversely, in Australia, where there was no change in concentration, turnover rose.

16. No. of banks doing 3/4 of turnover

17. How rank the euro, electronic broking and consolidation? • Overall decline: $280 billion. • Intra-EMU turnover, 1998: $110 billion. • Decline in spot interdealer transactions 1998-2001: $130 billion. • Decline in interdealer transactions 1998-2001: $220 billion (note double-counting of spot interdealer decline).

18. Note that euro and EBS/Reuters reduced turnovrer in 1995-98 • Intra-EMU transactions: $200 billion in 1995, $110 billion in 1998, $0 in 2001. • Electronic broking: 5% of spot interbank trading in 1995, 20-30% in 1998 and 40% in 2001. • Hard to explain decline in turnover in 1998-2001 with two forces equally at work in 1995-1998.

19. Consolidation as the answer? • Process accelerated 1998-2001, so could explain why trading declined then. • Consolidation in part a response to euro and electronic broking. • But cannot explain why transactions with non-financial customers fell by even larger fraction. • Could consolidation in the corporate sector be part of the explanation?

20. Cross-border mergers & acquisitions

21. Cross-border M&A can internalise foreign exchange transactions • M&A itself can require big, one-time forex order, but merged firm may have smaller order flow. • Example: Daimler-Chrysler: sales of Benz’s in US and Jeeps in Europe formerly led to forex orders but now need not go through market (depending on the organisation of the corporate treasury).

22. MNCs had growth spurt in late 90s

23. II. Regional developments • Asia-Pacific centres generally gain market share in global trading. • Northeast Asian currencies gain share • Differences across centres in Asia-Pacific reflect differences across currencies and relocation of dollar/yen and dollar/euro trading from Singapore and HK to Tokyo.

24. Developments by centre • Top 4 global centres tended to lose share • Japan proved the exception, on the strength of interdealer swap turnover, in euro and yen, especially among foreign institutions. • Next 4 centres tended to gain market share.

25. Market share by centre

26. Developments in Asia-Pac currencies • Most gained market share • As noted, gain by yen could be expected given introduction of euro • But A$, HK$, KRW, NZ$ and NT$ all showed substantial increases (although offshore trading in last 3 not measured separately in 1998).

27. Trading in Asia-Pac currencies

28. Northeast vs Southeast Asia • In part, growth of trading in NE Asian currencies reflects renewed foreign participation in stock markets in 2001. • Southeast Asia, however, barely on international investors’ screens in 2001. • This difference may help account for reduced transactions in Singapore. • Also repatriation of KRW turnover to Seoul • And limits on offshore trading of MYR, etc

29. III. Interest rate derivatives still growing smartly • Currency swaps and options show reduced activity • But FRAs and especially interest rate swaps show huge increases in activity

30. OTC interest rate derivatives surge

31. Swaps becoming the benchmark? • In US, swaps favoured by credit events (LTCM) and supply announcements that create painful basis risk for hedgers of private instruments. • In Europe, swaps favoured by differences in credit and liquidity across national issuers and single-issuer deliverability of successful government futures contracts.

32. Swap turnover

35. Conclusions I. Overall forex trading down due to euro, electronic broking and consolidation, both financial and non-financial. II. Most Asia-Pacific centres gained share and some Asia-Pacific currencies enjoyed increased turnover. III. Interest rate derivatives still growing smartly as swaps challenge government securities for benchmark status.

36. References • www.rba.gov.au/MediaReleases/mr_01_20.htm • www.bis.org/publ/rpfx01.htm. • www.info.gov.hk/hkma/eng/press/2001/20011009e3_index.htm • www.boj.or.jp/en/siryo/stat/fxdm0104.htm • www.mas.gov.sg/index.cfm?id=DDEFB3BF-6716-4F13-8FDE8A39E7722DE8 • Gabriele Galati, “Why has global FX turnover declined? Explaining the Triennial Survey”, BIS Quarterly Review (forthcoming December 2001).