January 30, 2015
Introduction to Financial Services: The International Foreign
Exchange Market
contract. Over-the-counter foreign exchange derivative
Overview
market transactions consist largely of interest rate contracts
(primarily interest rate swaps and forward rate agreements
The international foreign exchange market is a vast,
in a single currency that are designed to manage exposure
complex assortment of globally dispersed actors and
to changes in interest rates over the duration of the swap).
transactions that comprise millions of transactions daily,
valued at trillions of dollars. On a daily basis, the value of
Foreign Exchange Market
global foreign exchange transactions eclipses the total
global value of economic output and the value of all traded
Market Activity. According to a triennial survey of the
stocks and bonds. These markets are highly liquid as a
world’s leading 53 central banks and monetary authorities
result of extensive global communications systems and
conducted by the Bank for International Settlements (BIS)
electronic trading venues that operate on a 24-hour basis.
in April 2013, spot transactions and foreign exchange
Foreign exchange markets respond rapidly to political and
swaps dominate the traditional foreign exchange markets,
economic events and instantaneously transmit market
as indicated in Table 1. Daily turnover in these foreign
signals across national borders. Unexpected or abrupt
exchange markets totaled more than $5.3 trillion in the
disruptions in the foreign exchange market can roil
survey, while daily turnover in the OTC market totaled $2.3
financial markets and economies around the globe with
trillion, primarily in interest rate instruments (swaps). In
broad implications for economic activity. In November
total, daily foreign exchange turnover was $7.7 trillion,
2014, U.S., U.K., and Swiss regulators fined five
more than three times the annual amount of U.S. exports of
international banks, including Citigroup and JP Morgan
goods and services.
Chase, $4.3 billion for manipulating the foreign exchange
market.
Table 1. Foreign Exchange Market Turnover
(daily averages in April of the year indicated, trillions of US
Foreign Exchange Transactions
dollars)
Foreign exchange (FX) markets facilitate international
Year 2007
2010
2013
commerce by making it possible for firms to exchange
Foreign Exchange Market Turnover
currencies for exporting and importing goods and services.
The markets also supply currencies for foreign investment,
Spot transactions
1.0
1.5
2.0
for purchases of financial instruments, and to currency
Outright forwards
0.4
0.5
0.7
traders attempting to gain profits from short-term
fluctuations in exchange rates. Some governments also hold
Foreign exchange swaps
1.7
1.8
2.2
foreign currencies as reserves to protect against fluctuations
Options
0.2
0.2
0.3
in currency exchange rates.
Total “traditional”
3.3
4.0
5.3
Trading in the foreign exchange market occurs in both
traditional markets with organized exchanges and
Over-the-Counter Derivatives Market Turnover
standardized products and in the over-the-counter (OTC)
Interest rate instruments
1.7
2.1
2.3
market that is informal with uniquely crafted products.
Traditional foreign exchange transactions consist of three
Total Market Turnover
5.0
6.0
7.7
kinds: spot transactions, forward transactions, swaps, and
United States



options. Spot and forward transactions are agreements that
involve trading currencies immediately at the market
Foreign exchange turnover
0.7
0.9
1.3
exchange rate (spot transactions) or at some pre-arranged
time in the future and at a pre-arranged rate of exchange
OTC derivatives
0.5
0.6
0.6
(forward transactions). A swap is a contract to exchange
Total U.S. turnover
1.3
1.5
1.9
currencies and to pay or receive interest payments over the
duration of the contract. An option is a flexible forward
Source: Bank for International Settlements, and Federal Reserve
transaction that allows the owner of the option to buy or sell
Bank of New York.
a specific amount of foreign currency at a certain price
before the pre-determined expiration date of the option
www.crs.gov | 7-5700

---

Introduction to Financial Services: The International Foreign Exchange Market
In June 2014, the outstanding notional amount of foreign
their holdings of dollars and dollar-denominated assets as
exchange OTC derivative contracts totaled $75 trillion,
safe assets as a result of increased financial openness and
while the comparable interest rate contracts totaled $560
exposure to capital flow volatility. In addition, regulatory
trillion. Daily foreign exchange market activity in the
reforms that require financial institutions to hold safe and
United States in the April 2013 survey amounted to $2
liquid assets as a buffer against adverse financial shocks
trillion, about one-fourth of the total global foreign
have added to this demand for dollars.
exchange market activity in April 2013. Two-thirds of the
daily U.S. foreign exchange market turnover was in
Figure 2. Currency Distribution of Global Foreign
traditional foreign exchange transactions, with one-third in
Exchange Market Turnover
foreign exchange derivatives.
(% share of average daily turnover, April 2013)
100
Markets by Geographic Region. Foreign exchange
trading activity is dominated by a few geographic locations,
90
as indicated in Figure 1. London is the largest trading
80
center, accounting for 40.9% of global volume. The United
States (New York) accounts for about half the U.K. share,
70
or 18.9% of global trading. The next five countries—
60
Singapore (5.7%), Japan (5.6%), Hong Kong (4.1%),
50
Switzerland (4.5%), and Australia (3.2%)—combined with
the U.K. and U.S. shares—account for more than 80% of all
40
foreign exchange transactions.
30
Figure 1. Geographical Distribution of Global Foreign
20
Exchange Market Turnover
10
(% share of average daily turnover, April 2013)
0
US dlr
Euro
Jp yen UK pd Au dlr
Sw fr
Ca dlr
Mx p Ch rnb NZ dlr
45

40
Source: Bank for International Settlements, December 2013.
35
Issues for Congress
30
Through the Dodd-Frank Wall Street Reform and
25
Consumer Protection Act (P.L. 111-203), Congress moved
20
to regulate parts of the foreign exchange derivatives (swap)
markets by: 1) registering and regulating swap dealers and
15
major swap participants; 2) implementing clearing and
10
trade execution requirements for certain foreign exchange
swaps; and 3) establishing record keeping and reporting
5
requirements. Congress may choose to use its oversight role
0
to ensure that the new requirements promote transparency
UK
US
Sing
Jp
HK
Sw
Au
Other
and greater stability in the foreign exchange derivatives
market and to determine if new laws or regulations are
Source: Bank for International Settlements, December 2013.
necessary. Congress may also choose to evaluate the
effectiveness of recent exchange market reforms in light of
The Role of the Dollar. The U.S. dollar is the most heavily
recent settlements with major banks over manipulation of
traded currency in FX markets, as indicated in Figure 2. It
the foreign exchange market. The increased role in
accounts for 87% of daily foreign exchange transactions
international markets of such emerging economies as China
and reflects the role of the dollar as the international reserve
may also pose challenges for the dollar over the long run as
currency. (Because two currencies are involved in each
the global economy’s reserve currency. Congress may
transaction, the sum of the percentage shares of individual
choose to assess and evaluate the continuing role of the
currencies total 200% instead of 100%.) In comparison, the
dollar as the most important reserve currency and possible
euro accounts for 33% of trades, the Japanese yen accounts
implications for U.S. economic and financial policies.
for 23%, and the British pound accounts for 11.8%. Other
currencies account for smaller shares: Australian dollar
James K. Jackson, jjackson@crs.loc.gov, 7-7751
(8.6%), Swiss franc (5.2%), Canadian dollar (4.6%),

Mexican peso (2.5%), Chinese renminbi (2.2%), and New
IF10112
Zealand dollar (2.0%). The dollar is used to fund
commercial activities and by governments and central
banks to intervene at times in foreign exchange markets or
as reserves to protect their currencies from the spillover
effects of global crises. Governments also have increased
www.crs.gov | 7-5700

---