Development and Functioning of FX Markets in Asia and the Pacific

• Author: Frank Packer,Richard M. Levich
• Published date: 01 February 2017
• DOI: http://doi.org/10.1111/fmii.12079
• Date: 01 February 2017

Development and Functioning of FX Markets

in Asia and the Pacific

BYRICHARD M. LEVICH AND FRANK PACKER

Global foreign exchange (FX) trading volume in traditional FX products and derivativesin

Asia and the Pacific has expanded rapidly over the last fifteenyears, more so than in other

regions. Asian currencies also have experienced exceptional growth in offshore turnover,

including non-deliverable forwards (NDFs). Trading activity on this scale spread across

many countries and currencies underscores the need for a well-functioning infrastructure

and exceptional risk management processes. While settlement risks are mitigated for the

vast majority of turnover through systems like CLS Bank, the Asia Pacific region would

benefit by having more countries and currencies become CLS enabled or tradable under

other Payment versus payment (PVP) systems. Though less pronounced than during the

global financial crisis, FX markets in the region experienced added turbulence during the

“taper tantrum” period of 2013. High turnover currencies tended to depreciate more after

taper announcements; though volatility rose more sharply in currencies with low turnover.

The FX market is a prominent venue for carry trades that are subject to crash risk. While

there is some evidence of herding behavior exacerbating this risk over the past decade, the

measures calibrated more recently do not suggest exceptional crowding into carry trades

ahead of the “taper tantrum” in 2013. At the same time, our measures of crowdedness

for the carry trade show considerable variation over time. Making crowdedness measures

publicly available might be advisable.

I. INTRODUCTION

Global foreign exchange (FX) trading volume has expanded rapidly in recent

years. According to BIS data, turnover in traditional FX products and derivatives

grew from an estimated $590 billion in daily turnover in 1989 to $5.3 trillion in

2013. Between 2010 and 2013 alone, the rate of increase in turnover was 35%. The

trading volume in the currencies of the 12 Asia Pacific jurisdictions that are the

focus of this paper – Australia, China, Hong Kong SAR, India, Indonesia, Japan,

Korea, Malaysia, the Philippines, Singapore, Thailand, and New Zealand – have

increased even more quickly over the past three years, at 56%. Tradingactivity on

this scale spread across this many countries and currencies underscores the need

for a well-functioning infrastructure and exceptional risk management processes.

The road map for our paper is as follows. Section II will cover recent trends

in FX markets in Asia and the Pacific, presenting salient facts from the BIS

triennial survey of FX market activity including growth, location of turnover for

the major currencies of the Asia Pacific, as well as turnover by counterparty.

Section III will shift attention to the evolution of institutional safeguards in FX

trading, notably CLS Bank and its role in enhancing FX market resilience during

the Global Financial Crisis (GFC) in 2008–2009, as well as the current situation

and outlook for the evolution of institutional safeguards in Asia and the Pacific.

Section IV will present a brief conjunctural analysis of the resilience of market

Corresponding author: Frank Packer, Bank for International Settlements, 8 Finance St, Central, Hong Kong.

Email: frank.packer@bis.org.

C2017Bank for International Settlements. Financial Markets, Institutions & Instruments C2017 NewYork University

Salomon Center and Wiley Periodicals, Inc.

4Richard M. Levich and Frank Packer

functioning in Asian currencies over the past decade and a half, while Section V

will then focus on a particular type of trade – the carry trade – which has at times

accounted for a sizable proportion of FX transactions in the currencies of Asia and

the Pacific. Using newly developed measures of crowdedness and liquidity, we

ask how prevalent the carry trade has been and what is the evidence concerning

its contribution to instability in FX markets in the region, most notably during the

global financial crisis and the more recent “taper tantrum” episodes in 2013.

II. TRENDS AND PATTERNS IN FX TRADING IN ASIA-PACIFIC:

EVIDENCE FROM THE TRIENNIAL SURVEY

The 2013 BIS Triennial Surveygives a snapshot of a variety of evolving trends in

FX markets, and allows us to gauge how future economic expansion and possible

institutional changes in the region might impact FX trading activity and risk

exposures. Conducted every three years since 1989, the survey we rely on in this

paper was completed in 2013. Fifty-three central banks participated and collected

data from about 1,300 banks and dealers about their FX trading activity during

April. Turnoverin more than 40 currencies was reported in spot, outright forwards,

FX swaps, currency swaps and FX options transactions.

TRADING IN ASIA-PACIFIC CURRENCIES VS.OTHERS

While the latest triennial survey documented robust global growth in FX

turnover, the currencies of the Asia Pacific showed stronger growth on the whole

than other major currencies. Table 1 documents the evolving share of foreign

exchange market turnover for the six most actively traded currencies of advanced

economies, as well as the New Zealand dollar. The three currencies of the Asia

Pacific economies (JPY/AUD/NZD) have gained share since 2010 relative to

other advanced economy currencies, rising to 23%1, 9% and 2% of overall

turnover, respectively, well above the shares of the 2010 survey, as well as the

survey of nine years earlier (2004). The 2010–2013 growth rates of the yen,

Australian and New Zealand dollars of 63%, 53% and 66% were well above

overall growth rates of turnover, both for advanced economy currencies (34%)

and for the global sample of currencies (35%).

Similarly, turnover in many of the currencies of emerging market economies

in the Asia Pacific have grown relatively rapidly (Table 2). The fastest growing

currency is the Chinese renminbi: its turnover grew by 249% between 2010 and

2013, and it now comprises the second largest share of trading among emerging

market currencies (after the Mexican peso). The Thai baht, Malaysian ringgit,

Indonesian rupiah, and Indian rupee all show very robust growthwell above global

1Increases in Japanese yen trading relative to the 2010 survey was in part due to a surge in late 2012

and early 2013 due to expectations and implementation of a change in economic and monetary policy

in Japan. Data from other FX surveys show signs of a subsequent decline from the peak (Bech and

Sobrun (2013)).

Development and Functioning of FX Markets in Asia and the Pacific 5

Table 1: Currency Distribution of Global Foreign Exchange Market

Turnover, Developed Markets

Net-net basis,apercentage share of average daily

turnover in Aprilb%Growth

2001 2004 2007 2010 2013 2010–2013

US dollar 89.9 88.0 85.6 84.9 87.0 38.0

Euro 37.9 37.4 37.0 39.1 33.4 15.1

Japanese yen 23.5 20.8 17.2 19.0 23.0 63.3

Australian dollar 4.3 6.0 6.6 7.6 8.6 53.2

Swiss franc 6.0 6.0 6.8 6.3 5.2 10.0

Canadian dollar 4.5 4.2 4.3 5.3 4.6 16.3

New Zealanddollar 0.6 1.1 1.9 1.6 2.0 65.6

Other developed

markets

18.2 20.9 20.5 17.0 15.8 25.3

Emerging markets 8.6 9.0 12.5 14.8 18.8 71.4

Others 6.5 6.5 7.5 4.6 1.6 . . .

Total 200.0 200.0 200.0 200.0 200.0 34.6

aAdjusted for local and cross- border inter- dealer double- counting (ie “net- net” basis).

bBecause two currencies are involved in each transaction, the sum of the percentage shares

of individual currencies totals 200% instead of 100%.

Source: Triennial Central Bank Survey.

averages at 123%, 95%, 50% and 40%, respectively. Similar to other emerging

market economy (EME) currencies, growth in turnover has been far in excess

of related country trade growth, consistent with the ongoing “financialisation”

of currencies (McCauley and Scatigna, 2011). The one biggest single exception

to robust growth has been the Hong Kong dollar, where a decline of −17.6%

since 2010 likely reflects its displacement by the RMB in a significant number of

transactions in Hong Kong SAR.

The triennial survey also documents that the U.S. dollar (USD) remains the

dominant global currency, one of the currencies in more than 87% of transactions

globally (Table 1). Asian currencies also overwhelmingly trade against the USD,

though at proportions somewhat lower than the global average. For the bulk of

this paper, when we focus on issues of liquidity and performance of FX trades

in Asia, we will focus on the USD pairs of currencies of the Asia Pacific. The

potential for other currencies to rise as significant alternatives to the U.S. dollar –

a phenomenon which has not yet been observed in the BIS triennial survey – we

leave for other research.

OFFSHORE TRADING

FX trading is increasingly taking place offshore, or outside the jurisdiction

where a currency is issued. Indeed, the past few triennial surveys have shown the

offshore share of total FX transactions to be steadily rising across a broad spectrum