IFSL RESEARCH

In partnership with:

FOREIGN EXCHANGE
2009
SEPTEMBER 2009 WWW.IFSL.ORG.UK

This IFSL report gives an overview of the foreign exchange market, the
largest and most liquid financial market in the world. The UK, and London
in particular, is by far the largest global market for foreign exchange trading,
well ahead of the US and Japan. Chart 1 Average daily turnover of global

OVERVIEW OF THE MARKET

foreign exchange
US dollars, (billions)1 Traditional markets2

Size of market Average daily turnover in traditional foreign exchange

4,500 Other foreign exchange instruments3

market transactions totalled $2.9 trillion in April 2009 (Chart 1), down
4,000

nearly a quarter on the previous year’s record total. Overall turnover,

3,500

including non-traditional foreign exchange derivatives and products traded

3,000

on exchanges, averaged around $3.1 trillion a day. The decline in trading

2,500

volume during the year was broad based across all currency pairs, instrument
2,000

types and geographic regions. Weaker global trade due to the economic
1,500

slowdown, a fall in activity by international investors in particular of hedge

1,000

funds, and deleveraging all contributed to the decline in trading.

500
0

Prior to this, between April 2005 and 2008, foreign exchange turnover
1995 1998 2001 2004 2005 2006 2007 2008 2009
1
April; 2 spot transactions, outright forwards and fx swaps

nearly doubled boosted by increasing participation by hedge funds and retail

3
currency swaps and options & exchange traded contracts

investors as well as the proliferation of electronic trading platforms which

Source: Bank for International Settlements; IFSL estimates based
on FXJSC, FXC, SFEMC, TFEMC data

have made it easier to access this market. The volume of foreign exchange
trading surged to record levels at the outset of the credit crisis as rate cutting
from central banks and high volatility in exchange rates caused a flight from
emerging market currencies to “safe-haven” currencies such as the US
dollar. The economic downturn did not interrupt liquidity in the foreign
exchange markets, and foreign exchange was one of the few sources of
steady profits for banks. Investors saw the foreign exchange market as a Chart 2 Main countries for foreign exchange
liquid market in which to invest at a time when the rest of the world's trading
financial markets were in turmoil. Global bank revenues from foreign
exchange trading benefitted from relatively strong trading volumes since the
% share
100

start of the credit crisis and higher commissions resulting from a widening of
foreign exchange trading spreads.
35.3% 36.5% 37.0%
80 37.5% Other

Traditional foreign exchange instruments which include spot transactions,

outright forwards and foreign exchange swaps accounted for 92% of global
60 5.7% 5.6% 6.0% 6.0% Singapore
7.6% 5.9% 6.1% 6.7% Japan

turnover in April 2009, up slightly on the previous year. Over-the-counter

(OTC) currency swaps and options generated 6% of turnover and
18.2% 17.4% 14.4% 13.9% US
40

foreign exchange futures and options traded on derivatives exchanges 2%.

The past year has seen a movement away from engaging in the foreign
20
32.2% 34.6% 36.5% 35.8% UK

exchange market for speculation, along with a shift away from very complex
and highly leveraged foreign exchange products in favour of cash products.
0
2004 2007 2008 2009
Source: Bank for International Settlements; IFSL estimates based

Trading locations Because foreign exchange is an OTC market where

on FXJSC, FXC, SFEMC, TFEMC data

brokers/dealers negotiate directly with one another, there is no central

exchange or clearing house. The UK was the main geographic centre for
foreign exchange trading with nearly 36% of the global total in April 2009.
The US was the second largest centre with 14% of the global total. Japan and

1
IFSL Foreign Exchange - September 2009

Singapore were the next largest centres with around 6% each. Most of the
remainder was accounted for by Germany, Switzerland, Australia, Canada,
France and Hong Kong.
London as a centre for foreign exchange trading Average daily turnover on
the UK’s foreign exchange market totalled $1,269bn in April 2009, with a
further $81bn traded in currency derivatives. Following an initial surge in
activity at the start of the credit crisis, trading fell by a quarter in the year up
to April 2009, back to pre-crisis levels. The bulk of trading in the UK is
conducted in London which is by far the largest global centre for foreign
exchange business. Despite the fall in trading in 2008, London maintained its
leading global share of foreign exchange trading. Twice as many dollars are
traded on the foreign exchange market in the UK than in the US, and more
than twice as many euros are traded in the UK than in all the euro-area
countries combined.
Main advantages of London as a centre for
foreign exchange trading
- A central geographical location between the US and
Asian timezones allowing London to work virtually
around the clock;
- Easy access to markets combined with a tradition of
welcoming foreign firms;
- High quality professional and support services;
- Substantial and modern physical assets, particularly
office accommodation;
- Efficient telecommunications infrastructure;
- Concentration of financial institutions. London has
more foreign banks than any other centre;
- A proportionate regulatory regime that’s effective,
fair and focused on the future, principled and risk
based;
- Use of the English language.

London’s leading position as a centre for foreign exchange trading reflects its
position as the main financial centre in Europe and the leading global
international financial centre. Around a half of European investment banking
activity is conducted through London. Four-fifths of European hedge funds’
Chart 3 UK foreign exchange market average

assets are managed in London, which is also Europe’s main centre for prime
daily turnover

brokerage services. Although prime brokers are usually associated with

US dollars billion1

equities, foreign exchange prime broking is increasing in importance

1,800
Traditional markets2
Other foreign

reflecting the rise of foreign exchange as an asset class.

1,600 exch. instrum.3

1,400

Foreign owned institutions, have accounted for around 70% of foreign

1,200

exchange trading in London in recent years. EU institutions alone generate

1,000

more than a quarter of the overall total. The 250 foreign banks located in 800

London exceed that of any other city. Although their share has decreased 600

somewhat during the past decade, foreign banks still held the majority (54%) 400

of UK banking sector assets at the end of 2008. 200

CHARACTERISTICS OF THE FOREIGN EXCHANGE MARKET

0
1998 2001 2004 2007 2008 2009
1
April; 2 spot transactions, outright forwards and fx swaps;
3
currency swaps and options

A foreign exchange transaction is a transfer of funds, from one country and

Source: Bank for International Settlements, Bank of England

currency to another. The exchange rate is a price, i.e. the number of units of
Foreign Exchange Joint Standing Committee

one currency that buys one unit of another currency. The market exchange
rate is determined by the interaction of the official participants in the market
(governments) and private buyers
and sellers. Chart 4 Structure of the foreign-exchange market

The foreign exchange market

consists of the interbank market,
Foreign exchange
brokers

customers (banks, corporations,

individuals, fund managers, etc.)
OTC interbank

and derivatives exchanges. The

Clients Banks market Banks Clients
(spot and forward

interbank market is a wholesale

transactions)

market which does not have a Securities Exchanges

centralized location for trading

Securities brokers Securities brokers
(futures and options)

(Chart 4). Participants in this Source: Prentice Hall

market, mostly commercial and

2
IFSL Foreign Exchange - September 2009

investment banks, trade directly with each other or through brokers. Business
is conducted over the telephone or electronically. The foreign exchange
market is a 24-hour market. The trading day begins in Asia, extends into
Chart 5 Time-of-day turnover of global
Europe and then into the US. As Chart 5 shows, trading activity is
foreign exchange

highest when major markets overlap, particularly early in the morning Electronic conversations per hour (1992-1993), London time

European time and at the opening of the North American markets.

45,000

40,000 Peak number

In foreign exchange every position involves buying one currency and

35,000

selling another so as long as there are movements in the exchange rate the
30,000

potential for profit exists. The leverage in this market can be high and traders 25,000

can take both long and short positions as short selling is virtually 20,000

unrestricted. Leverage in this market means that actual funds required to

open a transaction can sometimes amount to only 1% or 2% of the value of
15,000

the opened position. One of the few limitations in the foreign exchange
10,000
Average number

market is that some emerging market countries exercise exchange control and
5,000

prevent their currencies from being freely traded. Due to the high liquidity of
0
100 300 500 700 900 1100 1300 1500 1700 1900 2100 2300

the foreign exchange market the cost of trading is typically lower than on
Asia Europe Asia US Europe US
coming coming going coming going going

other financial markets. From 2001 to 2007, spreads in foreign exchange

in in out in out out

markets contracted, meaning banks were making less margin. Spreads have
Source: Reuters

widened since the start of the credit crisis, due to increased volatility, a fall in
the number of dealer desks and increased concerns about counterparty risk.
This has resulted in boosting global banks’ revenue from foreign exchange
dealing.

FOREIGN EXCHANGE AS AN ALTERNATIVE INVESTMENT

Foreign exchange has developed into an asset class (a type of investment

such as for example stocks or bonds) over the past decade. This is partly
because it is uncorrelated to any other asset class. Pressures on fund
managers to deliver greater returns from their assets have led them to
looking outside traditional asset classes. As the world’s largest over-the-
counter market, foreign exchange is attractive to investors due to its deep
liquidity, volatility, and low-cost per trade.
Chart 6 Global foreign exchange market
Traditional instruments generated over 90% of foreign exchange turnover in
turnover by transaction type
April 2009. This included spot transactions, which accounted for 38% of
% share of traditional market instruments

traditional trading (up from 31% a year earlier), outright forwards 12% (up
100 4% Gaps in reporting1 5%

from 11%) and foreign exchange swaps 45% (down from 53%) (Chart 6).
Non-traditional transactions were in OTC currency swaps and options which
80

generated 6% of overall turnover and exchange traded contracts 2%.

54% Foreign exchange 45%
swaps
60

Main trading currencies The dollar is by far the most widely traded 12%

currency. This is because of its multiple roles: as an investment currency in

40 11% Outright forwards

many capital markets; a reserve currency for many central banks; a 20

transaction currency in many international commodity markets; and an

32% Spot transactions 38%

invoice currency in many contracts.

0
2001 2004 2007 2009
incomplete reporting of deals or incomplete coverage of the

The US dollar was involved in 86% of foreign exchange transactions in April

1

range of transactions

2009, followed by the euro 39%, Japanese yen 23% and pound sterling 15%
Source: Bank for International Settlements; IFSL estimates based
on FXJSC, FXC, SFEMC, TFEMC data

(Chart 7). Because two currencies are involved in each transaction, the sum
of the percentage shares of individual currencies totals 200%. Sterling’s share

3
IFSL Foreign Exchange - September 2009

fell from 17% in 2004 to 15% in 2009 but was still up on its 9% share a Chart 7 Currency distribution of reported
decade earlier. The shares of most other leading currencies also fell during foreign exchange market turnover
this period as trading in emerging market currencies increased. % share
200

US dollar/euro was the most widely traded currency pair in April 2009 with
36% 37% 36% Other

28% of overall turnover. US dollar/yen was the next most traded currency
Pound
13% 15%

pair, generating 18% of turnover, followed by US dollar/pound sterling with

150 17% Sterling
23% 23%

11% (Chart 8). Emerging market currencies accounted for around 7% of

20% Yen

market turnover. Their share has grown in recent years as they offer potential
38% 37% 40% Euro

for higher profits although the risks involved are generally higher.
100

Exchange rate trends The US dollar exchange rate has appreciated sharply
50 90% 89% 86% US dollar

against many currencies since the start of the credit crisis. Its traditional role
as a safe haven currency and movement away from emerging market
currencies helped it appreciate over 10% against the euro and 40% against
0
2001 2007 2009

the pound between September 2007 and February 2009 before giving back
Source: Bank for International Settlements; IFSL estimates based

some of the gains. Low yielding currencies such as the Yen also benefitted
on FXJSC, FXC, SFEMC, TFEMC data

from the flight to “safety”. Prior to this, apart from a brief period where the Chart 8 Foreign exchange turnover
dollar appreciated after the launch of the euro, it has generally been on a by currency pair
downward trend (Charts 9 and 11). Factors which can influence the level of % share
35 April 2007
Types of foreign exchange trading 30
April 2009

Investors can trade directly or indirectly in foreign exchange through foreign exchange OTC
instruments and exchange traded contracts:
25

a) OTC instruments are traded on the global interbank market and include:
20

15
Outright contracts Straightforward exchanges of one currency for another that are conducted
on the interbank market with various settlement dates:
10

- Spot transactions settle two business days after the deal date. The spot rate is the current
5

market price. 0
USD/EUR USD/GBP EUR/JPY
- Forward transactions are settled on any pre-agreed date three or more business days after the
USD/JPY USD/CHF Other

deal date.
Source: Bank for International Settlements; IFSL estimates based
on FXJSC, FXC, SFEMC, TFEMC data

Foreign exchange swaps are transactions where one currency is swapped for another and than
swapped back at a pre-agreed rate on a pre-arranged date; Chart 9 Foreign exchange rates of major
Currency swaps are transactions where counterparties exchange and re-exchange both
currency pairs
principal and streams of fixed or floating interest payments in two different currencies; index %1,
(100 = 1/1/2001)
OTC currency options An option is a contract that gives the holder the right, but not the 120
obligation to buy or sell a currency at a specified price within a specific time frame. OTC
US dollar/

currency options are customised options where no clearing house stands between the two
British pound
110 US dollar/
parties.
yen
100

b) Exchange-traded contracts cover trade in a number of foreign exchange products through

organised derivatives exchanges. US exchanges account for around 90% of trading in foreign
90

exchange contracts: 80

Currency futures are contracts for future delivery of a specified unit of foreign 70
currency at a fixed price at a specified date. Futures contracts are in standard amounts,
US dollar/

whereas forward contracts are once-only transactions.

60 euro

Exchange traded currency options are options traded in standardized contracts and amounts for
50
2001 2002 2003 2004 2005 2006 2007 2008 20092
a limited number of currencies and maturity dates. Higher index equals stronger US dollar; 2up to August 2009
1

Source: Oanda

4
IFSL Foreign Exchange - September 2009

an exchange rate include political and economic conditions, most Chart 10 Foreign exchange rates of major
importantly interest rate differentials and balance of payments imbalances. non-US dollar currency pairs
Governments sometimes participate in the foreign exchange market to
influence the value of their currency.
index %1,
(100% = 1/1/2001)
150

MARKET PARTICIPANTS 140

Foreign exchange traders include governments, commercial and investment

euro/yen

banks, international corporations, fund managers and individual private

130

investors and speculators. 120

Interbank market The traditional foreign exchange market is made up of

110

commercial and investment banks and other financial institutions which euro/british pound

handle spot, outright forwards and foreign exchange swaps on the OTC
100

market. These major dealer banks developed into an interbank market for
90

foreign exchange through their frequent dealings with each other in an effort
2001 2002 2003 2004 2005 2006 2007 2008 2009
1
Higher index equals stronger euro

to find buyers and sellers of currency. There are around 2,000 dealer
Source: Oanda

institutions worldwide.
Chart 11 Foreign exchange rates since start
Dealers In the interbank market dealers trade foreign exchange directly with
of the credit crisis
other dealers via the telephone or through electronic brokerage systems.
index %1,

Dealing companies are mainly commercial and investment banks which trade
(100 = 1/9/2007)

amongst themselves based on strong credit relationships as part of their

150 US dollar / British pound

system of balancing accounts. Trades are usually to fill customer orders.

140

Banks also trade on their own account although these are usually short term 130

positions. 120

The largest traders deal in all major currencies and cross-trades as well as
110 US dollar / euro

some emerging countries’ currencies. They also handle forwards, options and
100

swaps and conduct market research for their customers. Some dealers 90

act as market makers for a selected number of currencies. Market

makers regularly quote both bid and offer prices for a currency and are
80
US dollar / yen

willing to commit their own capital to complete transactions at the prices they
70
9/07 2008 20092

quote.
1
Higher index equals stronger dollar; 2up to August 2009
Source: Oanda

Inter-dealer trading generated 34% of foreign exchange activity in April 2009

(Chart 12), down from nearly two-thirds a decade earlier. The large volume
Chart 12 Global foreign exchange market

of trading is because a customer transaction often leads to further multiple

turnover by counterparty

transactions as banks readjust their own positions to hedge, manage or offset

% share
100

the risks involved. Inter-dealer trading as a proportion of total business has

With non-financial 7%
17%
customers

fallen over the past decade due to advances in technology which have 80

reduced the need for intermediaries.

20% With other
financial institutions
59%

The largest volume of foreign exchange trading involves large banks.

60

Table 1 shows the estimated market share of leading foreign exchange

dealers. This market is becoming more concentrated with Deutsche Bank,
40

UBS AG and Barclays Capital accounting for more than 45% of trading in
63% With reporting

May 2009. This was up on the 22% share of the top three dealers in 2000.
20 dealers
34%

The closure of a number of large investment banks in 2008 has contributed

to the increase in concentration.
0
2001 2004 2007 2009
Source: Bank for International Settlements; IFSL estimates based
on FXJSC, FXC, SFEMC, TFEMC data

5
IFSL Foreign Exchange - September 2009

Brokers The role of a broker in the interbank market is to bring together a

buyer and a seller of a currency in return for a commission. Usually broker
Table 1 Largest foreign exchange dealers
companies quote currency with a spread, that includes their fee. Whereas a
dealer may take one side of a transaction and commit their own capital, a
% of overall volume, May 2009

broker does not take a position and relies purely on the commission received Deutsche Bank 21.0

for the services provided. The share of business conducted through brokers
UBS AG 14.6

varies in different countries due to differences in market structure and ranges

Barclays Capital 10.5
Royal Bank of Scotland 8.2

from 10-15% in Switzerland and South Africa to around 50% in France,

Citigroup 7.3

Netherlands and Ireland.

JP Morgan 5.4
HSBC 4.1
Goldman Sachs 3.4

Clients of banks on the interbank market generated 67% of foreign exchange

Credit Suisse 3.1

turnover in April 2009, of which financial customers 59% and non-financial

BNP Paribas 2.3
Other 20.1
customers 7%. Clients include corporations, fund managers, individuals and
Source: Euromoney FX survey

central banks. In the past most foreign exchange transactions were a result of
companies’ processing of import and export transactions or to fund payrolls
for international offices. Over the past thirty years, however, investment in
financial assets has increased more rapidly than trade. Institutional investors,
Chart 13 Official foreign exchange reserves
hedge funds and other fund managers are major participants in the foreign
exchange market. Retail investors participation has also grown rapidly since
% share by country

the mid-1990s. This was facilitated by the advent of electronic trading

and currency, June 2009

platforms.
36% Other
China

Central banks are also clients on the interbank market. They are large
Others 28%

players with access to significant capital reserves (Chart 13). China in

37%

particular has increased its foreign exchange reserves in recent years. Central
US

banks can buy and sell their domestic currency on the market to
64% dollar

influence exchange rates or may seek to accumulate, reallocate or reduce

14%
US 5% Japan

their foreign exchange reserves. Many also handle a large proportion of

1% 5% 9%
India

foreign exchange transactions for the government and other public sector
Russia Euro-area

enterprises. Total: $7,500bn

Speculation versus investment Foreign exchange trading is by nature

Source: Wikipedia, IMF

speculative. Speculators are attracted to the opportunities that volatile and

changing market conditions create. Some traders take on positions on a
leveraged basis which magnify market movements. Almost anyone who buys
or sells foreign exchange takes a view on the future direction of exchange
rate movements. An arbitrary line can be drawn between those who deal in
currency to insure against exchange rate changes to cover exports or imports
of goods or services, and those who deal in currency aiming to make a
profit on exchange rate fluctuations. Some estimates indicate that as much as
95% of foreign exchange trading is speculative.

CHANGING STRUCTURE OF THE MARKET

Consolidation and concentration The number of companies providing

foreign exchange dealing services has fallen since the start of the credit
crisis due to the closure of a number of banks. This consolidation is a
continuation of a decade-long trend resulting from mergers and increased
competition with the proliferation of electronic trading platforms. In the UK,
the share of the largest 10 institutions rose from 61% to 70% between 2004
and 2007, continuing the trend from the 1998 and 2001 survey (Chart 14).

6
 IFSL Foreign Exchange - September 2009

Electronic broking and internet There are two basic types of electronic
systems. Those that connect dealers amongst themselves in the interbank
Chart 14 Concentration of foreign exchange

market and those that connect dealers with customers. Over the past few
market in the UK

years electronic broker systems or automated order matching systems have

% share of daily Other firms

gained a significant share of the spot interbank market. This has increased
turnover in Next largest 10 firms
April Largest 10 firms

transparency and allowed smaller banks access to the same prices traded by
100
10%

the bigger dealers. The market took a giant leap forward when banks started
20% 20%
31%

offering their clients direct access to proprietary platforms with streaming

80 20%

prices. As a result, the distinction between the interbank and other markets
22% 19%

has blurred.
60 19%

The proportion of global FX trading volume executed through electronic

40
70%

systems surged to 53% in 2008, according to Greenwich Associates, up from

58% 61%
50%

44% in the previous year. This will approach the 80 per cent mark by 2010.
20

Celent estimates that three-quarters of the interdealer spot market volume and
a half of dealer-to-client volume is traded electronically.
0
1998 2001 2004 2007
Source: Bank of England

The development of internet trading platforms has made the customer

segment of the foreign exchange business more competitive and has allowed
for the emergence of non-bank service providers. This has also prompted a
Chart 15 Electronic trading in FX markets

greater need for peripheral and add-on services for customers such as, for
example, research. Internet trading remains however, in the early stages of
% share of
turnover

development and still accounts for only a small percentage of the overall
forecast
80

trading volume. 70

60

50

40

30

20

10

0
2000 2006 2007 2008 2009 2010

Source: TABB Group; IFSL estimate

7
 IFSL Foreign Exchange - August 2009

LINKS TO OTHER SOURCES OF INFORMATION: IFSL Research:

Bank for International Settlements Report author: Marko Maslakovic
Triennial central bank survey of foreign exchange and derivatives market activity Director of Economics: Duncan McKenzie
www.bis.org d.mckenzie@ifsl.org.uk +44 (0)20 7213 9124
Senior Economist: Marko Maslakovic
Bank of England
m.maslakovic@ifsl.org.uk +44 (0)20 7213 9123
The foreign exchange and over-the-counter derivatives markets in the UK
www.bankofengland.co.uk International Financial Services London
29-30 Cornhill, London, EC3V 3NF
European Central Bank www.ifsl.org.uk/research
Review of the foreign exchange market structure ------------------------------------------------------
www.ecb.int International Financial Services London (IFSL) is a private
sector organisation, with nearly 40 years experience of
Federal Reserve Bank of New York successfully promoting the exports and expertise of UK-
The foreign exchange market in the US based financial services industry throughout the world.
www.ny.frb.org
This report on Foreign Exchange is one of 16 financial sector
reports in IFSL’s City Business Series. All IFSL’s reports can
Foreign Exchange Joint Standing Committee be downloaded at www.ifsl.org.uk.
www.bankofengland.co.uk/markets/forex/fxjsc/index.htm
© Copyright September 2009, IFSL
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www.newyorkfed.org/fxc
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