Why is london most likely the top market for trading foreign exchange?

By Anirban Nag, Jamie McGeever

LONDON (Reuters) - The foreign exchange market’s status as the world’s largest, built up over decades of rampant globalization, deregulation and growth in financial services, is unlikely to be relinquished any time soon. But the glory days are over.

Euro, Hong Kong dollar, U.S. dollar, Japanese yen, pound and Chinese 100 yuan banknotes are seen in this picture illustration, in Beijing, China, January 21, 2016. REUTERS/Jason Lee

Overall market volume and employment levels at the biggest banks trading currencies are shrinking, as tighter bank regulation, the fading emerging market boom and a secular slowdown in world growth and trade take their toll.

Industry figures show the number of traders employed in Europe at the top 10 foreign exchange banks is down 30 percent over the last three years. Figures from the Bank of England and New York Federal Reserve last month showed that trading volume has fallen to its lowest level in three years.

The days when close to $6 trillion changed hands on an average day may never return, industry observers say, as tighter bank regulation, the fading emerging market boom and secular slowdown in world growth and trade take their toll.

According to financial industry analytics data firm Coalition, the top 10 FX banks alone operating in Europe employed 332 people on their G10 European FX trading desks last year. That’s down 30 percent from the 475 employed in 2012.

The vast majority of those frontline positions are in London. Both inside and outside the UK capital, countless other jobs in back office areas servicing the market have also likely disappeared for good even if quantifying that is trickier given the multiple areas these people work across.

“The end of 2014 was a peak in global FX activity,” when average daily volume was around $6 trillion a day, said one central banker in Europe.

Data from CLS Bank, which offers the world’s largest multilateral cash settlement service, showed average daily volume in January was $4.8 trillion, down 9 percent from a year earlier and a far cry from the near $6 trillion peak.

Trading desks at some of the biggest banks in London and New York -- the largest centers in foreign exchange -- are grappling with lower volumes in actively traded currencies like the yen, Swiss franc and Australian dollar over the past year.

Spurred by huge losses for many from the Swiss franc’s surge in January last year, big banks have cracked down on the number of smaller hedge fund-style operations they issue credit to and the leverage ratios they give others, halting the growth of highly leveraged speculative trading.

The trend was highlighted in a recent survey by central banks in Britain and the United States that showed daily volumes were down 21 percent in April to October 2015 from a year earlier in London and 26 percent in New York.

“The $5 trillion-plus-a-day volumes that we saw is probably the peak for the near term,” said Jim Cochrane, a foreign exchange industry veteran and a director at ITG, an independent broker to institutional investors and hedge funds.

YOU NEVER GIVE ME YOUR MONEY

The foreign exchange market, which is used as a snapshot of global trade and economic activity, is the world’s biggest financial market, and had been growing steadily for decades.

Twenty years ago, volumes averaged $1.2 trillion daily, according to the Bank for International Settlement’s 1995 global survey, the first time volume was above the $1 trillion mark.

But a market-rigging scandal that erupted in 2013 and led to several banks being fined billions of dollars and dozens, possibly hundreds, of traders around the world suspended or fired has cast a long, dark shadow over the industry.

More regulatory changes, prompted by the global financial crisis, has reduced their ability and willingness to take trading risks.

Besides contending with higher capital costs and rising costs of doing business as spending on risk management, surveillance and technology rises, banks can no longer trade currencies on their own behalf.

“The impending regulatory changes have had a psychological impact on market participants’ behaviors and traders are no longer being as aggressive as they were before,” said Howard Tai, senior analyst with Aite Group, a financial research and consultancy group.

Analysts say relatively subdued volatility in the foreign exchange market has played a role in keeping volumes low in recent months. Spot volumes have fallen and so did demand for derivative products such as currency options given there can be little demand to hedge if currencies are not going anywhere.

“Zero interest rates and a very dovish environment globally means there is less volatility,” said Douglas Borthwick, managing director at Chapdelaine FX in New York, a division of Tullett Prebon, a inter-dealer money broker.

“When volatility is clamped down, then volumes collapse.”

Traders are banking on some volatility spilling over from unsettled financial markets and a slowdown in China to force a major rethink of where asset prices, inflation, growth and central bank policy are headed this year.

Whether the increased turmoil will also lead to a boost in currency trading is an open question.

By Andrew MacAskill, Tommy Wilkes

LONDON (Reuters) - Britain has extended its lead in the global currency trading business in the two years since it voted to leave the European Union, in another sign London is likely to continue to be one of the world’s top two financial centres even after Brexit.

Leaving the European Union was supposed to deal a crippling blow to London’s position in global finance, prompting a mass exodus of jobs and business. But with eight months to go, London has tightened rather than weakened its grip on foreign exchange trading, a Reuters analysis shows.

Foreign exchange - the largest and most interconnected of global markets, used by everyone from global airlines to money managers in transactions worth trillions of dollars a day - is the crowning jewel of London’s financial services industry.

Reuters’ analysis, based on surveys released by central banks in the five biggest trading centres, shows forex trading volumes in Britain had grown by 23 percent to a record daily average of $2.7 trillion (£2.1 trillion) in April compared to April 2016.

(GRAPHIC: Top foreign exchange trade centres - tmsnrt.rs/2L8YwyZ)

That was double the pace of its nearest rival, the United States, which was up 11 percent to $994 billion, mostly out of New York.

That means about two-fifths of all trades are handled in Britain, nearly all of them in London - a daily volume almost equivalent to the annual economic output of the United Kingdom.

The next three biggest markets are Singapore, which fell by 5 percent to $523 billion; Hong Kong, which grew 10 percent to $482 billion; and Japan, which increased by 2 percent to $415 billion.

London has dominated the foreign exchange market for nearly half a century.

FILE PHOTO: British Pound Sterling and U.S. Dollar notes are seen in this June 22, 2017 illustration photo. REUTERS/Thomas White/Illustration/File Photo

Investment banks earned $4.2 billion in revenues from foreign exchange business globally in the first quarter of 2018, about 12.5 percent of all revenues in their global markets divisions, according to data from industry analytics firm Coalition.

While forex trading reaps relatively low margins, it brings in other business, allowing lenders to cross-sell other services such as interest-rate products, equity and bond issuance and advice on mergers and acquisitions, said former currency trader Keith Pilbeam, now a professor at the Cass Business School.

“It is all about getting people in,” Pilbeam said. “Selling forex is the best introduction to a company because you are talking to the treasurers of these companies.”

Bankers and traders attribute an overall growth in trading to global political uncertainty, including around Brexit itself. They also cite the presidency of Donald Trump and the threat of trade wars involving the United States, China and the EU.

London’s time zone between the United States and Asia means it is well placed in times of global turbulence, they said.

Increased volumes help the biggest players because investors want to buy and sell in markets that have the capacity to absorb large deals without significantly affecting prices.

Finally, London’s advanced FX trading hardware and high-speed sub-Atlantic cables to New York make it costly and troublesome for forex operations to move, they said, especially given that banks have a tendency to want to group together.

“The luck of geography has helped because most of the big market moving news, whether in the U.S. or Europe, has occurred during London’s trading hours,” said Neil Jones, London-based head of hedge fund sales at Japan’s Mizuho Bank.

“You may have all the uncertainty around Brexit, but this is outweighed by London’s time zone, its language, and the advantages that come from having the biggest market.”

BREXIT BATTLEGROUND

The forex industry has emerged as a battleground between Britain and the EU in negotiations on what will replace current treaties and agreements after Brexit day on March 29, 2019.

Some EU leaders want to strip banks in Britain of the right to sell FX derivative products, which allow investors to hedge against swings in the price of currencies, to EU-based clients.

These products, the largest part of Britain’s currency market, are sold to customers around the world, not just the EU.

Banks in Britain, including the London operations of global players, are moving some staff to European cities on expectations that they will the lose the automatic right to sell services to EU investors after Brexit.

Companies that run trading platforms, such as Thomson Reuters TRI.TO - the parent of Reuters News - and NEX Group NXGN.L are shifting parts of their businesses to Dublin and Amsterdam to prepare for life after Brexit. 

But Brexit supporters say the threat of job losses in Britain’s financial services industry has been exaggerated.

Tokyo, Hong Kong and Singapore had been eroding London’s dominance before the June referendum, the Bank of International Settlements (BIS) said in its last major three-year survey of global forex activity in September 2016.

The city’s tightening grip on forex trade does not prove London won’t suffer from Brexit, but it does underscore the attractiveness for banks of maintaining large international operations in the city, industry experts said.

“In order for London to be replaced there needs to be an alternative venue and there isn’t one,” said Alexander McDonald, the chief executive of industry group European Venues and Intermediaries Association.

“The FX market is effectively an offshore dollar market and offshore dollars are always going to be looking for an international home, and that’s London.”