of each participant can vary dramatically. Surveys over recent years tend to indicate
that participants can broadly be divided into three main groups: banks, brokers and clients.
Commercial banks are by far the most active, while brokers act as intermediaries. Clients can
be classed as anything from multinational corporations to individual investors to speculators.
Who then are the active participants in this global market?
GOVERNMENTS
Governments sometimes have requirements for foreign currency. This may be for paying staff
salaries and local bills of an embassy abroad, or for a foreign currency credit line, most often
in dollars, to a third world national government for industrial or agricultural development. In
its turn, the third world nation’s government will periodically have to pay interest due on any
foreign loans, with the capital sum eventually having to be repaid. It is more than likely that
the government would approach the market via its own central bank or a commercial bank.
Foreign exchange rates are of particular concern to governments because changes in foreign
exchange rates affect the value of products and financial instruments. As a result, unexpected
or large changes can affect the health of a nation’s markets and financial systems. Exchange
rate changes also impact a nation’s international investment flow, as well as export and import
prices. These factors, in turn, can influence inflation and economic growth.
For example, suppose the price of the Japanese yen moves from 120 yen per dollar to 110
yen per dollar over the course of a few weeks. In market jargon, the yen is ‘strengthening’, or
becoming more expensive against the dollar. If the new exchange rate persists, it will lead to
several related effects:
1. Japanese exports to America will become more expensive. Over time, this might cause
export volumes to America to decline, which, in turn, might lead to job losses in Japan.
2. The higher American import prices might be an inflationary influence in America.
3. American exports to Japan will become less expensive, which might lead to an increase in
American exports and a boost to American employment.
BANKS
Central banks
Central banks are the traditional moderators of excess. The Bank of England, the European
Central Bank, the Swiss National Bank, the Bank of Japan and, to a lesser extent, the Federal
Reserve Bank will enter the market to correct what are felt to be unnecessarily largemovements,
often in conjunction with one another. By their actions, however, they can sometimes create
the excesses they are specifically trying to prevent.
Intervention, in general, does not shift the balance of supply and demand immediately.
Instead, intervention affects the present and future behaviour of investors. In this regard,
intervention is used as a device to signal a desired exchange rate movement.
The second group of banks can best be described as aggressive managers of their reserves.
Some of the Middle Eastern and Far Eastern central banks fall into this category. They are
major speculative risk takers and their activities often disturb market equilibrium. Along side
this activity, the central banks have clients in their own right and they will have commercial
transactions to undertake. In certain countries, central banks are involved in local fixing sessions
between commercial banks, often acting as an adjudicator to the correct fixing of the daily
rates, or to ensure that the supply and demand for foreign currency is balanced at a rate that is
in line with its current monetary policy.
Trading banks
Banks (trading banks) deal with each other in the ‘interbank market’, where they are obliged
to make a ‘two-way price’, i.e. to quote a bid and an offer (a buy and a sell price). This
category is perhaps the largest and includes international, commercial and trade banks. The
bulk of today’s trading activity is concentrated between 100 and 200 banks world wide, out of
a possible 2000 dealer participants. These banks also deal with their clients, some of the more
important of which also qualify for two-way prices. In the vast majority of cases, however,
most corporations will only be quoted according to their particular requirement. These banks
rely on the knowledge of the market and their expertise in assessing trends in order to take
advantage of them for speculative gain.
Commercial banks
Commercial banks (clearing banks in the UK) operate as international banks in the foreign
exchange market, as do many retail banks in other major dealing centres. Many banks in
the UK have specialized regional branches to cater for all their clients’ foreign business,
including foreign exchange. All this retail business will eventually be channelled through
to the bank’s City of London foreign exchange dealing room for consolidation with other
foreign currency positions either for market cover or continued monitoring by the specialist
dealing-room personnel.
The situation in America is slightly different, where legislation prohibits banks in certain
states from maintaining branch networks, but all banks have their affiliates or preferred agents
in the main dealing centres of New York, Chicago and Los Angles.
Other commercial banks have large amounts of foreign exchange business to transact on
behalf of their clients, and although they will have their own dealing rooms, for one reason or
another they have not developed their operations to become involved in the interbank foreign
exchange markets.
Regional or correspondent banks
Regional or correspondent banks do not make a market or carry positions and, in fact, turn to
the larger money centre banks to offset their risk. Such relationships have been built up over
many years of reciprocal service, and in many instances are mutual, whereby the correspondent
bank abroad acts as the clearing agent in its own currency for the other bank involved.
Investment and merchant banks
The strength of investment and merchant banks lies in their corporate finance and capital
markets activities, which have been developed over many years’ servicing the financial needs
of large corporations, rather than retail clients. With the multi-currency sophistication of the
capital markets and the wide international spread of corporations and other market participants,
they are frequently required to transact foreign exchange business, which they effect either by
dealing direct or through the brokers’ market.
BROKERING HOUSES
Brokering houses exist primarily to bring buyer and seller together at a mutually agreed price.
The broker is not allowed to take a position in a currency and must act purely as a liaison.
For this service, they receive a commission from both sides of the transaction, which will vary
according to currency handled and from centre to centre.
However, the use of live brokers has decreased in recent years, due mostly to the rise of the
various interbank electronic brokerage systems.
INTERNATIONAL MONETARY MARKET
The International Monetary Market (IMM) in Chicago trades currencies for contract amounts,
which are relatively small in size and for only four specific maturities a year. Originally designed
for the small investor, the IMM has grown apace since the early 1970s, and the major banks,
whose original attitude was somewhat jaundiced, now find that it pays to keep in touch with
developments on the IMM, which is often a market leader.
MONEY MANAGERS
Money managers tend to be large New York commission houses and are frequently very
aggressive players in the foreign exchange market. They act on behalf of their clients, but often
deal on their own account. They are not limited to one time zone, but deal around the world
through their agents as each centre becomes operational.
CORPORATIONS
Corporations are, in the final analysis, the real end users of the foreign exchange market.With
the exception only of the central banks that alter liquidity by means of their intervention, it
is the corporate players by and large who affect supply and demand. When the other major
players enter the market to buy and sell currencies, they do so not because they have a need,
but in the hope of a quick and profitable return. The corporates, however, by coming to the
market to offset currency exposure, permanently change the liquidity of the currencies being
dealt with.
RETAIL CLIENTS
Alongside these corporates, there is a non-too-significant volume from retail clients. This
category includes many smaller companies, hedge funds, companies specializing in investment
services linked to foreign currency funds or equities, fixed income brokers, the financing of
aid programmes by registered worldwide charities and private individuals. With the rise in
popularity of online equity investing, and a corresponding rise in online fixed income investing,
it was only a matter of time before the average retail investor began to see opportunities in
the foreign exchange market. Retail investors have been able to trade foreign exchange using
highly leveraged margin accounts. The amount of trading, both in total volume and in individual
trade amounts, remains low and is certainly dwarfed by the corporate and interbank markets.
OTHERS
Other financial institutions involved in the foreign exchange market include:
- Stockbrokers
- Commodity firms
- Insurance companies
- Charities and private institutions
- Private individuals.
SPECULATORS
All the above tend to have some sort of underlying exposure that has to be covered. Speculators,
however, have no underlying exposure to hedge, rather they attempt to fulfil the adage ‘buy
low, sell high’ by trading for trading profit alone. Foreign exchange is an ideal speculative tool,
offering volatility, liquidity and easy margin or leverage. This activity is vital to the stability of
the markets. Without speculation, hedgers would find the market too illiquid to accommodate
their needs.
While speculators seek excess profits as a reward for their activities, the process of speculat-
ing itself drives the markets towards lower volatility and price stability. No modern commodity,
equity or debt market could operate without the speculators. It is estimated that up to 90% of
the daily volume of trading activity in the foreign exchange markets is a result of speculator
activity, with the balance primarily made up of commercial hedging transactions.
Source: A Foreign Exchange Primer
