BIS Survey: On Uncertainty and Trading Volumes

Before we go anywhere, let me first talk a little bit about the BIS. You can think of the Bank for International Settlements (BIS) as the Big Kahuna of central banks. As an international organization which fosters cross-border monetary policy and financial cooperation, it serves as a central bank for central banks.

Because of the role that it plays, the BIS is also a hub for statistical information among central banks. It regularly publishes statistics on global banking, securities, foreign exchange, and derivatives markets. Its most recent data released on May 7 is part of the bank’s semi-annual OTC derivatives report which looked at industry numbers from June to December 2012.

Although the BIS doesn’t report on the retail forex industry per se, note that data gathered from OTC FX derivatives transactions can lead us to some conclusions on how the forex market fared in the latter part of 2012 and how it can react to recent industry developments.

According to the latest report, foreign exchange derivatives continued to see high demand during the period. For the most part, statistics affirm the crucial role that foreign exchange plays in facilitating cross-border trade and providing stability to businesses. However, it’s noteworthy to mention that there was a $6 trillion drop in the notional outstanding amount, which is indicative of trading volumes, to $633 trillion.

The BIS survey attributes the overall decline in trading volumes to two main factors. First is the shaky market environment brought forth by central bank intervention, poor consumer confidence, and economic uncertainty during the period. Second is the shifting regulatory framework, as several industry watchdogs started implementing stricter rules last year. For instance, Japan imposed a restriction which limited forex trading companies to a maximum leverage of 1:25.

Industry expert Zohar Hod of SuperDerivatives noted that uncertainty in the market is generally a “real bug bear for both the buy and sell side” as companies and financial institutions have to consider the increased level of risk in their forex transactions. Higher levels of uncertainty make these institutions more hesitant to take on larger trading volumes which could expose them to more risk.

Moving forward, uncertainty in both market environment and regulatory conditions could continue to play a role in driving overall trading volumes.

So far, the first quarter of the year has painted a more robust picture of trade activity, as forex trading volumes showed a decent recovery across most brokers. This can probably be explained by the lack of major changes in industry regulation for the first few months of the year.

Note, however, that some risks concerning monetary policy and central bank intervention have started to pop up again. As Forex Gump discussed in his latest entries, some central banks continue to implement aggressive easing measures while others have surprisingly cut rates or stepped in the currency market to devalue their currency.

Do you think we’ll see another drop in trading volumes this year? Let us know what you think by voting through our poll below!