Structural change in the foreign exchange market: implications for the SNB
Andréa M. Maechler / Thomas Moser, Member of the Governing Board / Alternate Member of the Governing Board
Money Market Event, Geneva, 11.11.2021
For two decades now, profound structural change has been taking place on the financial markets, and the pace of this change has picked up significantly due to the ongoing digital revolution. New technologies, new tools and new players have altered not only the outward appearance of these markets but also their underlying dynamics. The transformation is particularly evident in the foreign exchange (FX) market, which has become a so-called 'fast-paced electronic market' - high-frequency, electronic and complex.
These changes are especially relevant for the Swiss National Bank (SNB), as the FX market plays an important role for monetary conditions in Switzerland as well as for the implementation of the SNB's monetary and investment policy. The SNB must therefore understand the developments taking place in the markets and identify their fundamental implications at an early stage. And it must do so at both a macroeconomic and a market microstructure level.
The structure of the FX market has changed significantly. On the one hand, it has become more fragmented and the relevance of primary markets is waning. On the other hand, the trend towards less transparent forms of trading, such as internalisation, is gaining momentum. This results in two key challenges. First, market transparency and the price discovery process may be affected, and this may impact the efficiency and robustness of the market. Second, the increasingly widespread use of automated trading tools, such as execution algorithms, is creating new liquidity and market dynamics. These developments call for new approaches to market monitoring and analysis.
Against this backdrop, the SNB, as a market participant, is ensuring that it has effective and broad access to the various trading platforms. As a market observer, on the other hand, the SNB needs to invest in new data, tools and analytical skills if it is to be able to adequately monitor and analyse the performance of the Swiss franc and the FX market.
In order to manage the large volumes of data as well as the growing speed and complexity of trading, central banks require an entirely new, state-of-the-art data architecture. The BIS Innovation Hub's Project Rio is a specific example of what such an architecture could look like. Project Rio has been customised for the FX markets, but it can also be used to analyse other relevant fast-paced markets; after all, the FX market is by no means the only market to be undergoing rapid structural change.
At the same time, the SNB sees the establishment of common standards and greater transparency as essential in a faster-paced and more complex market environment. It therefore reaffirms its commitment to the FX Global Code and recommends that FX market participants in Switzerland and Liechtenstein observe its principles.