Short Memories, Long Horizons

The following was written by James Sinclair, Executive Chairman and Co-Founder, MarketFactory.

“Annual income twenty pounds, annual expenditure nineteen, nineteen and six, result happiness.
Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”
– Wilkins Micawber in Charles Dickens’s David Copperfield

The 2016 Bank for International Settlements (BIS) Triennial survey showed a decline in volume, the first in 15 years. Some commentators, with echoes of Dicken’s Mr. Micawber, seem to view any drop as cause for great concern and any increase as a source of confidence. This view is misplaced. It ignores the lessons of history and confuses volume with value.

Certainly, the FX market faces challenges in the wake of recent misconduct, indirect consequences of the Swiss franc move, and increased capital requirements, to mention a few. However, we have seen, survived, and subsequently thrived following equally serious issues, and the changes are creating new opportunities.

Looking first at history, the total volumes in 2016 fell 6% over the prior survey in 2013, and Spot fell 15% over the same period. However, we have seen steeper drops between triennial surveys. In 2001, the total volumes fell 16%, and Spot volumes fell 32% from three years before.


There was a clear explanation for the drop in 2001: the introduction of the euro. History is never a surprise—after it happens. At the time, the extent of the drop was unexpected, and it caused significant problems for many participants whose business models relied on volume, including some voice and electronic brokers. There were two main causes for the greater-than-expected drop. First, the market underestimated the extent to which the pre-euro volume depended on legging into pairs, such as dollar–lira from mark–lira and dollar–mark. Second, there was a greater-than-expected impact due to the lack of historical euro data, which may seem obvious now.

However, volumes then took off at a pace that we had not contemplated before. Whereas volumes grew at a compound annual growth rate of 6.7% until 1998, they grew at 14.9% from 2001 to 2013.

Even more significantly, looking at volume alone masks more subtle patterns. As noted in the BIS Quarterly Review, December 2016, there appears to have been a change in the composition of participants in recent years. The market has proportionately more activity from institutional investors, such as insurance companies and pension funds. Indeed, the institutional investor FX swap volume rose by 80% over the same three year period in which the overall spot market volume fell 15%.

At the other end of the spectrum, there is evidence of less high-frequency trading, the effects of “speed bumps” in the form of latency floors by major inter-dealer platforms, and higher prime brokerage costs, particularly following the Swiss franc move in January 2015. However, even in that sector, FX trading by hedge funds and proprietary trading firms dropped by 50% and 10% in London and New York, respectively, while volumes for these participants grew by 80% in Hong Kong, doubled in Singapore, and tripled in Tokyo. Furthermore, the financialization of the renminbi is growing, and renminbi trading volumes now rank just behind the Swiss franc and Canadian dollar.

There are genuine concerns, of course, including the concentration of major market makers and prime brokers affected by higher capital charges. However, depending on how you make your money, the changing profile of market participants may be more important and create more opportunities than the simple growth of market volume.

Wilkins Micawbers, as manager of the Port Middlebay Bank, would surely take note.

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