Runaway FX turnover growth tamed by crisis

LONDON (Reuters) - Global market turmoil has triggered an explosion in the number of currency trades going through banks' dealing desks but it's not all good news.

Years of steady increases in the amount of money pulsing through the $3.2 trillion-a-day foreign exchange market are coming to an end as soaring volatility forces some of the biggest players, such as hedge funds, to run for cover.

Industry specialists, who had confidently predicted average daily foreign exchange turnover would approach a record $4 trillion this year, are consequently adopting more conservative forecasts.

"There's been an increase in trading velocity but we've not seen a commensurate rise in total value, in fact the opposite," said Jonathan Butterfield, vice president of marketing and communications at leading FX settlement bank CLS.

"A little earlier this year, one might have said we're walking toward the $4 trillion level (but now) we don't think total value traded has risen."

London's position as the global hub of currency trading was cemented with figures in April from the Foreign Exchange Joint Standing Committee (JSC) showing a one-third rise in daily turnover from the preceding six months.

But Paul Fisher, head of the Bank of England's Foreign Exchange Division and reserves management, said this week the JSC's next survey detailing October FX turnover could show a slowdown.

That view contrasts with some leading settlement venues and trading platforms, which have reported very healthy numbers.

CLS, for example, said the average number of daily FX payment instructions surged to a record high in October, a month characterized by sharp price swings across asset classes as fallout from the global credit crunch mushroomed.

The trends behind the numbers are a little more sobering.

ICAP data showed electronic spot FX trading volumes on the EBS platform averaged $243.8 billion daily at the height of the financial turmoil in October, up 22 percent year-on-year but down from September's peak of $274.2 billion.

And CLS says that in the first two weeks of November, values eased somewhat from the record highs seen in October.

Total values settled in currency swaps, which involve the exchange of principal and interest in one currency for the same in another, have fallen amid rapid changes in interest rates as central banks scramble to drag their economies out of recession.

HEDGE FUNDS BUTTON UP

In recent years, phenomenal growth in global FX volumes has been driven by hedge funds, sovereign wealth funds, central banks and other investors, who have all added to liquidity provided by traditional players such as interbank dealers.

Interest among funds in currency as an asset class also boomed, with a proliferation of strategies to hedge exposure and also to extract maximum profits from market moves.

But extreme price swings have taken their toll on some currency trading models, which were designed for a more benign backdrop when it comes to volatility.

FX volatility leapt in October as huge dislocation in all markets caused investors to unwind positions rapidly.

Implied volatility on one-week and one-month dollar/yen currency options spiked to their highest in decades, even surpassing levels seen at the time of the Long Term Capital Management and Russia debt default crises in 1998.

The extreme volatility has also reduced the amount of automated, computer-driven trading, with many market participants caught off-guard.

"Our clients certainly faced some challenges getting their business executed," Philip Weisberg, chief executive officer at online currency platform FXall told Reuters.

OUTLOOK UNDIMMED

While the froth may have come off FX turnover growth, industry specialists say banks are continuing to make money out of the currency business, which has been one of the few bright spots in otherwise ailing balance sheets.

"The market is in very good shape, with many banks reporting record profitability in the recent period," said Justyn Trenner, CEO and Principal of consultancy Clientknowledge.

"The lack of liquidity has meant that clients who need to get business done are both having to pay an appropriate client spread and also trading at a wider bid/offer spread," he added.

With volatility seen staying at elevated levels for some time yet, some trading venues are not complaining.

"Trading could not be better for us. The rest of the economy -- they suffer when there is volatility. For us, life get's better," one senior industry source said.

(Reporting by Veronica Brown and Jessica Mortimer; Editing by Stephen Nisbet)