March 2008

Unprecedented FX market growth

From 2004 to 2007, the foreign exchange (FX) market grew at an unprecedented rate. The triennial FX volume survey, released by the Bank for International Settlements (BIS), reflects a significant increase in global trade and investment (Figure 1).

*Data for 1989 and 1992 include only spot, forward and FX swaps, not options or cross-currency interest rate swaps.

The BIS survey compiles FX volume data gathered by a multitude of central banks from their local country banks - termed reporting dealers. These reporting dealers break out their volume in a number of ways, including the products they transact (e.g., spot, forwards and swaps), the currency pairs they transact and those with whom they transact.

The 2007 numbers tell an interesting story. While volumes grew across all counterparty segments - banks, institutional investors and corporate customers - half of the volume increase was from one particular group, the "with other financial institutions" counterparty segment (Table 1, Figure 2). This segment includes pension funds, mutual funds, insurance companies, sovereign wealth funds and hedge funds.

Table 1 

*Data only include traditional instruments, including spot, forward and FX swaps.
Source: Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity

In addition to straight outright purchases of foreign currencies for global investments, this segment has increased its use of currency overlay strategies to hedge the currency risk associated with these foreign investments. The volume growth of FX swaps, the primary vehicle for implementing currency overlay, was also unprecedented (Figure 3).

If you need to protect your foreign investments from currency risk, you can contact CIBC's foreign exchange risk consulting group for assistance. This group works with institutional and corporate clients to identify, quantify and construct appropriate strategies for managing currency exposures.

Feb. 5, 2008

By Sharon Grewal, executive director, foreign exchange risk consultancy group, CIBC World Markets 

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