VoxEU Column Financial Markets International Finance

The $4 trillion question: What explains FX growth since the 2007 survey?

Daily average foreign exchange market turnover reached $4 trillion in April 2010, 20% higher than in 2007. This column describes how recent growth is largely due to the increased trading activity of “other financial institutions”, which include high-frequency traders, banks trading as clients of the biggest dealers, and online trading by retail investors.

In April this year, 53 central banks and monetary authorities participated in the eighth Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity (BIS 2010). The 2010 Triennial shows a 20% increase in global foreign exchange (FX) market activity over the past three years, bringing average daily turnover to $4 trillion (Table 1 and Figure 1, left panel). The data show that 85% of the growth in FX market turnover since 2007 reflects the increased trading activity of “other financial institutions” – a broad category that includes smaller banks, mutual funds, pension funds, hedge funds, and other financial institutions. For the first time, activity by other financial institutions surpassed transactions between reporting dealers (i.e. inter-dealer trades), reflecting a trend that has been evident over the past decade (Figure 1, centre panel).

Figure 1.

Table 1. 

Given that most of the growth in FX market activity since 2007 is due to increased trading by other financial institutions, the $4 trillion dollar question is: Which financial institutions are behind this growth? The Triennial data do not break down trades within this category of counterparty. Discussions with market participants, data from regional FX surveys and an analysis of the currency composition and location of trading activity provide some useful clues. Taken together, they suggest the increased turnover is driven by:

  • greater activity of high-frequency traders;
  • more trading by smaller banks that are increasingly becoming clients of the top dealers for the major currency pairs; and
  • the emergence of retail investors (both individuals and smaller institutions) as a significant category of FX market participants.

This column based on our recent research (King and Rime 2010) explores the contribution of each of these customer types to the growth of global FX turnover.

Increase in FX market turnover driven by algorithmic trading

An important structural change enabling increased FX trading by these customers is the spread of electronic execution methods. The investment in electronic execution methods has paved the way for the growth of algorithmic trading. In algorithmic trading, investors connect their computers directly with trading systems known as electronic communication networks. Examples of such electronic networks in FX markets are electronic broking systems (such as EBS and Thomson Reuters Matching), multi-bank trading systems (such as Currenex, FXall and Hotspot FX) and single-bank trading systems (such as BARX from Barclays, Velocity from Citigroup, and Autobahn from Deutsche Bank). A computer algorithm then monitors price
quotes collected from different ECNs and places orders without human intervention.

Algorithmic trading is an umbrella term that captures any automated trades where a computer algorithm determines the order submission strategy. For example, FX dealers use algorithms to automatically hedge risk in their inventories or to clear positions in an efficient manner.

Customers are increasingly using execution management systems that break up trades and seek the best market liquidity to reduce market impact. Hedge funds and proprietary trading desks use algorithms to engage in macro bets, statistical arbitrage or some form of technical trading. All these activities are contributing to the increase in FX turnover.

High-frequency trading is one type of algorithmic trading that has received considerable media attention1. It is a trading strategy that profits from incremental price movements with frequent, small trades executed in milliseconds. While it emerged over a decade ago in equity markets, it became an important source of FX growth from 2004.

High-frequency trading takes place in the deepest and most liquid parts of the FX market, namely the spot FX markets for the major currency pairs. Market estimates suggest it accounts for around 25% of spot FX activity, or as much as $375 billion per day. This number can unfortunately not be verified using the data in the Triennial survey.

Banks trading increasingly as clients of top dealers

While banks engaged in FX markets below the top tier continue to be important players, the long-term trend towards greater concentration of FX activity in a few global banks continues (Figure 1, right-hand panel). The largest dealers have seen their FX business grow by investing heavily in their single-bank proprietary trading systems. The tight bid-ask spreads and guaranteed market liquidity on such platforms are making it unprofitable for smaller players to compete for customers in the major currency pairs.

Increasingly, many smaller banks are becoming clients of the top dealers for these currencies, while continuing to make markets for customers in local currencies. This hybrid role allows smaller banks with client relationships to profit from their local expertise and comparative advantage in the provision of credit, while freeing them from the heavy investment required to compete in spot market-making for the major currency pairs.

Growing importance of retail as an investor class

More than any other customer segment, electronic trading has opened up the FX market to retail investors – a trend highlighted already in the discussion of the 2007 Triennial survey. Trading by households and small non-bank institutions has grown enormously, with market participants reporting that it now accounts for an estimated 8-10% of spot FX turnover globally ($125–150 billion per day). Japanese retail investors are the most active, with market estimates suggesting this segment represents 30% or more of spot Japanese yen trading (ie more than $20 billion per day).

The rapid growth of retail FX trading has led to increased regulation. Regulators have introduced registration of online FX dealers, raised their capital requirements and introduced other measures to protect consumers such as requiring the segmentation of customer funds. The US Commodity Futures Trading Commission recently reduced the cap on retail leverage from 100:1 to 50:1 for major currencies (and 20:1 for other currencies). Japan’s Financial Services Authority also reduced leverage to 50:1, with plans to reach 25:1 by 2011. Greater regulation has led to consolidation in this industry, with the number of retail electronic trading platforms (termed retail aggregators) in the US declining from 47 in 2007 to 11 today and in Japan from over 500 in 2005 to around 70 today. In the UK and continental Europe, however, there are currently no limits on leverage and limited regulation, creating the potential for regulatory arbitrage.


Electronic trading is transforming FX markets and encouraging greater trading activity by different classes of investors. During the three-year period from 2007 to 2010, the main contribution to the growth of FX turnover appears to come from high-frequency traders, banks trading as clients of the biggest FX dealers and retail investors trading online. While electronic execution methods have initially boosted growth in the main financial centres, this trend is also likely to lift turnover in other countries in the coming years. At the same time, the relative importance of inter-dealer trading may continue to decline as banks match more customer trades internally.

The views expressed in this article are those of the authors and do not necessarily reflect those of the BIS or the Central Bank of Norway.


BIS (2010), Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2010 - Final results, December.

King, Michael R and Dagfinn Rime (2010), “The $4 trillion question: what explains FX growth since the 2007?”, BIS Quarterly Review, 13 December.

1 While the 6 May 2010 “flash crash” in US equity markets was initially blamed on high-frequency trading, the report by the US Securities and Exchange Commission relieves it of any responsibility, pointing instead to the order execution algorithm of a US mutual fund.