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Foreign exchange market activity declined markedly between 1998 and 2001. This is in sharp contrast to the previous surveys, which had shown substantial growth in trading volumes. Average daily turnover in traditional foreign exchange markets was estimated at $1,210 billion in April 2001 compared to $1,490 billion in April 1998, representing a 19% decline (Table 1). The introduction of the euro, the growing share of electronic broking in the spot interbank market and consolidation in the banking industry appear to have been the main factors driving this fall in foreign exchange market turnover.

The decline was most pronounced in spot markets, where average daily turnover fell from $568 to 387 billion. Trading volumes in foreign exchange swaps dropped from $734 to 656 billion, or by 11%. By contrast, trading in outright forwards slightly increased to $131 billion.

The April 2001 figures also reveal some changes in the relative importance of trading between different counterparties. Trading between reporting dealers fell substantially, from $909 to 689 billion (Table 2). In April 2001, it captured 59% of total turnover, down from 64% in 1998. This can in part be explained by the growing role of electronic brokers in the spot interbank market. The use of electronic brokers implies that foreign exchange dealers generally need to trade less actively among themselves. Trading between banks and non-financial customers also declined markedly, from $241 to 156 billion, while transactions between banks and financial customers rose from $279 to 329 billion. The higher trading volumes between banks and other financial institutions seem to have reflected the increasing role of asset managers rather than the activity of hedge funds. In fact, market commentary suggests that the role of hedge funds in foreign exchange markets has on balance declined somewhat since the previous survey.

In terms of the currency composition of foreign exchange market activity, the main impact of the introduction of the euro appears to have been through the elimination of intra-EMS trading. Thus the euro entered on one side of 38% of all foreign exchange transactions – higher than the Deutsche mark’s share in 1998 (30%) but lower than that of all euro constituents taken together in 1998 (53%). The relative importance of other currencies seems not to have changed substantially since 1998. The dollar’s share in foreign exchange markets edged up from 87% in 1998 to 90% in 2001 (Table 3). The yen’s share increased slightly to 23% in 2001.

Dollar/euro was by far the most traded currency pair in 2001 and captured 30% of global turnover (Table 4). It was followed by dollar/yen with 20% and dollar/sterling with 11%. Trading in local currencies in emerging markets captured about 4.5% of foreign exchange activity in 2001, compared with 3.1% in 1998.

Preliminary data for 2001 reveal an overall decline in the number of reporting banks: 2,772 in 48 countries compared to 3,087 in 43 countries in 1998. This is consistent with the broad trend towards consolidation in the banking industry and the consequent reduction in the number of trading desks. This trend seems to have been an additional factor contributing to the decrease in foreign exchange market turnover, especially in the interbank market.

The geographical distribution of foreign exchange trading appears not to have changed substantially over the last three years (Table 5). Turnover fell in most countries, with some notable exceptions. In Japan, turnover increased mainly because of a surge in cross-border foreign exchange swaps. In Sweden and Canada, a relaxation of restrictions on institutional investors boosted foreign exchange market activity. In Australia, activity rose as a number of global players have centred their Asian time zone foreign exchange business in Australia. Market commentary pointed to a tendency among commercial banks in some continental European countries to move foreign exchange business to London, while in some other countries banks tended to concentrate their business in their home country. On balance, these two trends appeared to have offset each other, as the United Kingdom’s share in total trading was little changed over 1998.

In the OTC derivatives market, average daily turnover in April 2001 amounted to $575 billion, exceeding that in April 1998 by 53% (see Table 6). The survey showed a contrast between interest rate and foreign exchange contracts, with the former continuing to grow at a rapid pace (by 85%, to $489 billion) and the latter contracting (by 31%, to $67 billion). This divergent path led to a further increase in the relative share of interest rate products in overall OTC derivatives activity, to 85% of total turnover compared with 71% in the previous survey. Data from derivatives exchanges had shown a similar, if less pronounced pattern, with an expansion of interest rate products and a contraction of currency instruments (see the memorandum items at the bottom of Table 6).

Expansion in the interest rate segment was driven by the buoyancy of interest rate swaps, with turnover rising by 114%, to $331 billion (see Table 6). Business in dollar-denominated swaps grew even faster than in the previous survey (by 178%, to $100 billion; see Table 7), reflecting a deepening of the market possibly driven by a shift in hedging and trading practices. Net repayments of US government debt have reduced the liquidity of long-term US government bonds, encouraging market participants to switch to more effective hedging and trading instruments, such as interest rate swaps. The higher turnover of dollar-denominated swaps thus reflects the increased importance of such instruments as trading and pricing benchmarks.

Activity in euro-denominated interest rate swaps also expanded rapidly (by 104%, to $173 billion). The consolidation of activity resulting from the introduction of the euro in January 1999 resulted in a temporary decline in business in European interest rate derivatives but this was quickly offset by the creation of a large and liquid market in euro-denominated swaps. With European government bond markets remaining heterogeneous, the euro-denominated swap curve has in effect become a new benchmark for European fixed income markets. By contrast, trading in yen-denominated interest rate swaps expanded much more slowly (by 14%, to $16 billion), with activity remaining below that recorded in 1995. The low volume of business may have reflected a fairly widespread view at the time of the survey that Japanese interest rates would evolve in a narrow range for the foreseeable future.

Trading in FRAs witnessed a fairly strong and broad-based expansion (by 74%, to $129 billion; see Table 7), following slower growth in the previous reporting period. By contrast, activity in interest rate options, a much smaller segment of the OTC interest rate market, contracted by 19%, to $29 billion, with much of the decline occurring in the yen segment.

Turnover in currency options, by far the largest group of ';non-traditional'; foreign exchange products, dropped substantially (by 31%, to $60 billion; see Table 8). Much of the decline was concentrated in the dollar/yen pair (-48%). Options involving the dollar and euro area currencies declined less sharply (-26%). Currency swaps, a relatively small segment of the OTC derivatives market, also contracted (by 30%, to $7 billion; see Table 8).

Overall, business within the group of reporting dealers grew faster (by 74%, to $354 billion; see Table 9) than transactions with non-reporting financial institutions (by 46%, to $159 billion), while transactions with non-financial customers declined (by 16%, to $42 billion). In contrast to the spot foreign exchange market, electronic broking has not yet made significant inroads into OTC derivatives markets. This may explain why inter-dealer business has remained buoyant relative to 1998. Lastly, cross-border activity grew more than twice as rapidly as local business (71% versus 34%). Cross-border contracts accounted for 58% of total activity, illustrating the global nature of the derivatives business.

1. Data on amounts outstanding of OTC foreign exchange, interest rate, equity, commodity and credit derivatives were collected at end-June and preliminary results will be published in November 2001.
2. National results are adjusted for local inter-dealer double-counting while global results are adjusted for both local and cross-border inter-dealer double-counting and for estimated gaps in reporting.
3. The five emerging market countries that in 2001 participated for the first time in the survey captured about 0.2% of total foreign exchange turnover (see Table 5).
4. Foreign exchange swaps commit two counterparties to the exchange of two cash flows and involve the sale of one currency for another in the spot market with the simultaneous repurchase of the first currency in the forward market. By contrast, currency swaps (or cross-currency swaps), which are discussed in the next section on OTC derivatives markets, commit two counterparties to several cash flows, which in most cases involve an initial exchange of principal and a final re-exchange of principal upon maturity of the contract, and in all cases several streams of interest payments.
5. The OTC market consists of ';non-traditional'; foreign exchange derivatives - such as cross-currency swaps and options - and all interest rate derivatives contracts.
6. It should be noted, however, that activity in the two types of markets cannot be directly compared owing to inherent differences in the characteristics and uses of products.
7. Comparing activity in legacy currencies in 1998 with that in the euro in 2001.