Disruption in the Foreign Exchange Market
OTC vs. Digital Currencies vs. Exchange Trading.
As the year comes to an end, we will not make any predictions for the New Year. Rather take a step back, look back to a year full of learning of new and exciting developments and look forward to what could be in the cards for the next 5 to 10 years.
Let’s take a snap-shot of the present market.
- Fragmented OTC market open 24hours, 5.5 days a week.
- Shrinking volumes.
- Electronic trading counts for majority of trades.
- Regulatory efforts touching mainly buy side.
- Sell side guided by Codes of Conduct and best practices.
Normalizing FX Volume figures.
BIS Triennial Bank Survey is a major source of volume numbers for the FX Market. It is our opinion that the daily average of $5.1 trillion per day is highly misleading, due to the methodology used. Since FX is an OTC market, volumes are computed differently than Exchange Volumes (EV) of an Exchange traded market, like equities. The BIS counts multiple purchases and sales, which are “only related” to a transaction in the open market/Exchange.
In other words, the size of the FX Market, compared to Exchange Volume is currently highly overstated.
BIS gross $20 million=BIS reported net $15 million=Exchange Volume $5 million
Please see below graph for more clarity.
Transaction 1, reported by UBS under “with other financial institutions” à $5 million gross, $5 million net
Transaction 2, reported by UBS under “with reporting dealer ” à $5 million gross, $2.5 million net
Transaction 2, reported by DB under “with reporting dealer ” à $5 million gross, $2.5 million net
Transaction 3, reported by DB under “with other financial institutions” à $5 million gross, $5 million net
“True Exchange Volumes” in Spot & Outright forwards would currently be more than 70% lower.
The current true Exchange Volume is even smaller, considering that large market makers have a 70% – 90% internalization ratio in G4 currencies. In other words, Transaction 1 or Transaction 3 might not lead to Transaction 2.
This would bring Exchange Volume below 30% of BIS numbers. In other words, current “theoretical Exchange Volumes” totals less than $700bio daily in Spot and Outright forwards.
- Market participants that run sophisticated executions models.
- Venues that base their business case, based on BIS volumes.
- Market participants that observe erratic moves with “little” volume.
- Market participants that believe OTC is the only way to trade FX, due to the size of this market.
- Market participants that believe the FX market is so big, it needs to be open 24hours a day.
5 Years outlook – FX Market 2022
Hybrid OTC & Exchange traded – Central cleared – FX as Commission Business
OTC trading as we know it. Restored trust due to stricter Code of Conduct.
Beginning of Central Bank issued Digital Currencies.
10 Years outlook – FX Market 2027
Central Bank issued Digital Currencies.
Exchange traded – Central cleared – FX as Commission Business.
How do you see this market evolve?
For our more detailed outlook or to further discuss the future of the FX Market and how to position your business, please feel free to contact us.