Dwindling FX volumes – except for China – are a systemic risk as hedge funds abandon currency markets says BIS

Jasper Jolly
Follow Jasper
China's Yuan Hits New Record High Against The Dollar
The decline in FX volumes has allowed the renminbi to gain market share (Source: Getty)

High-risk investors are abandoning the foreign exchange markets, potentially leaving the financial markets more vulnerable to systemic dangers, according to a group of top central bankers.

The decline in foreign exchange volumes has also allowed China’s renminbi to gain market share, according to the Bank for International Settlements (BIS).

Currency markets have “changed in favour of more risk-averse players,” as hedge funds and individual traders move away from foreign exchange, and high-frequency traders reach “saturation point”, says the bank.

Read more: These are the world's two most systemically important banks

On the supply side, prime brokerage volumes have also declined significantly under regulatory and profit pressure, according to the Basel-based bank’s economists and Michael Moore, professor of finance at Warwick Business School.

Turnover in global FX markets declined for the first time since 2001 from $5.1 trillion per day in April 2016, compared with $5.4 trillion in 2013 at the last triennial survey. FX trading peaked in September 2014, at $6.4 trillion per day.

Economists at the influential BIS, often known as the “central banks’ central bank”, are concerned the reduced liquidity could increase risk in the global financial system.

Hyun Song Shin, BIS head of research said: “This is a matter of first-order importance. Any major changes to liquidity conditions might have consequences for market risk and the effectiveness of the hedging strategies of corporates, asset managers and other foreign exchange end users.”

Read more: People's Bank of China sets renminbi fix at weakest in six years

However, the falling volumes have been a boon to the liquidity of the renminbi, as it becomes increasingly important to the world’s financial system.

The share of activity in Asian financial centres has quadrupled over the past three years, now accounting for four per cent of trading by hedge funds and high-frequency traders. It now rivals the Swiss franc and the Canadian dollar in terms of volumes traded.

This year the renminbi was accepted as one of the IMF’s reserve currencies, elevating the its prominence in international finance.

Related articles