A new analysis of the 2013 Triennial FX Survey shows that the traditional bifurcation of the market between interdealer and customer segments has collapsed, leaving a much more diverse group of counterparties. These include hedge funds, small and regional banks, pension and mutual funds, high-frequency trading firms, central banks and sovereign wealth funds.
This growing diversity implies a broader range of counterparty motives, trading patterns, time horizons and liquidity needs than the old interdealer/customer market structure exhibited. This in turn could lead to less correlation in some parts of the market, which could be a boon for hedgers.
The 2013 Triennial showed that global FX turnover hit a record high of $5.3 trillion per day, up 35 percent from the prior survey, which itself reflected a 20 percent increase. According to the study, “The evolving structure of the global FX market – Insights from the 2013 triennial survey,” transactions with non-dealer counterparties grew almost 50 percent and accounted for about two-thirds of the overall increase.
Nearly a quarter of the non-dealer market participants are now smaller banks, which trade sporadically to provide specialized services to their clients and are therefore less driven by short-term price and liquidity variables. By contrast, asset managers and hedge funds each comprise 11 percent. The hedge fund group includes high frequency trading firms, which are driven almost exclusively by short-term price and liquidity variables. The authors of the study, Dagfinn Rime of Norges Bank and Andreas Schrimpf of the Bank for International Settlements, write, “The ecology of the FX market has clearly been affected by the increased participation of such players.”
The authors write that the growth of the prime brokerage business has facilitated entry by a broader variety of financial institutions. “The traditional market structure based on dealer-customer relationships has given way to a trading network topology where both banks and non-banks act as liquidity providers,” they write. “This is effectively a form of ‘hot potato’ trading, but where dealers are no longer necessarily at the center.”
The greater volume and counterparty diversity has increased trading velocity but has also brought a number of new sources of liquidity to the FX world. If this means more consistent demand during times of market stress, it would be a big help to FX traders and hedgers alike.