BoJ Paper Paints a Picture of an FX Centre Trying to Catch Up

Japan has always been an FX centre with a difference – mainly because it was less “international” than London and New York in particular – but in recent years, the centre has found itself losing ground in the Asian region as well, something that is addressed in a new paper from the Bank of Japan, which paints a picture of a centre trying to modernise, whilst maintaining some of its unique characteristics.

The relative decline in activity in Japan has been a regular feature of these pages, but even so, there was some surprise in the latest round of FX committee turnover surveys, when activity in Tokyo fell to its lowest since April 2019. One has to go back to 2017 to find a volume survey notably lower than the October 2024 reading.

It could be that the latest report is a true representation of a longer-term decline, one that has been disguised by regular boosts from yen volatility as first the carry trade became popular once again, and then when the Japanese authorities intervened to buy yen. At least two of the intervening surveys from 2020 have seen Bank of Japan intervention in the survey month, and others have come soon after, meaning activity levels were still high.

A new paper published by the Bank of Japan, Electronic Foreign Exchange Trading: Developments in and Implications for the Tokyo FX Market, in its latest Bank of Japan Review series, acknowledges the relative decline in activity and looks at some of the potential reasons behind it. The paper also asks some questions that have been prevalent in other centres for some time now – namely does increased fragmentation and the decline of the primary venues inhibit price discovery, and does this trend make it harder for authorities to monitor market developments?

The paper notes that the e-FX ratio in markets in Japan has risen to 50% from just 20% when the semi-annual survey started in 2005, however this is lagging behind other centres, where it has risen closer to 70%. The reason for this, a situation where there is growth but not at the pace expected, is, the paper suggests, how Japan has something of a bifurcated market when it comes to e-FX, mainly because two big influences on turnover trade in very different fashions.

On one hand, retail aggregators have been a big part of the centre’s growth, indeed the paper notes that “many venues focus on attracting FX retail aggregators, and the trend for FX retail aggregators is significant when monitoring the e-FX trend”, but on the other, corporations remain on the telephone.

The paper observes that the “large share” for corporates in the Japanese FX market is “one of the factors” pushing down the e-ratio, because the sector does not have uniform preferences when it comes to how they trade. In interviews conducted by the Bank of Japan, corporations that prefer voice trading stated that they value the relationship with their main bank when selecting a market maker and have “little need” to compare multiple prices. The paper adds that the small size and low frequency of these firms’ trades makes it hard to motivate them to adopt e-FX. Additionally, these firms appreciate the opportunity to access market colour from their dealers, the paper says.

As the e-FX infrastructure advances internationally, the presence of the Tokyo market as a financial centre may be affected

The paper lays out the concerns expressed previously in other centres over the challenges of price discovery when the primary venues are seeing less volume and also looks at the “complexity” of the FX market landscape, concluding, “While a greater choice of available venues increases the opportunities for customers to trade at more favourable prices, they must also make appropriate choices among the differently characterised venues to meet their trading needs. The difficulty of making such choices is further compounded by the fact that each venue has different characteristics in terms of the implications of information on price and liquidity.”

Although it does not overtly state such a premise, there is no getting away from the sense that Japan very much sees its diminishing role on the world stage in FX as a result of infrastructure. The paper even uses Singapore and its growth in FX trading over the past eight years following the authorities’ initiative to attract more e-trading to the centre, as an example. “As the e-FX infrastructure advances internationally, the presence of the Tokyo market as a financial centre may be affected, involving an outflow of FX transactions to other financial centres,” the report warns. “Careful monitoring of e-FX is important to follow trends in FX trading and changes in market structure.”

Overall, the paper very much reads like a call to both the local market and authorities to focus more on automation, to ensure that Tokyo does not become, outside of the yen, a backwater in FX terms. It could be argued, of course, that Tokyo has existed for the past 20 years or more as a specialist yen centre – indeed, Bank for international Settlements’ data from its Triennial Survey over the years seems to confirm this.

While turnover has almost trebled from 2001 to 2022 in Japan, the centre’s share of the FX market has more than halved, from 9.1% to 4.4%. This is also reflected in the yen more broadly, where the share of turnover (on a double-counted basis) has dropped from 22.7% in 2001, to just 10.3% in 2022.

These data indicate not only the scale, but the long-term nature of the decline in the significance of the Japanese FX market. The centre remains an important one for many players, but in a more focused manner, largely the retail aggregators that are happier to trade away from local banks than their corporate brethren.

In these circumstances, it would seem natural that Japan creates an FX infrastructure that can allow a more diverse group of players to participate in the centre, but perhaps more importantly, that retains those players that are currently e-trading there. The march of technology seems inexorable, therefore it seems vital that the local market is ready for, in particular, a swathe of corporates that may switch to e-trading in the future.

If and when that happens, the awkward question will be, has the centre acted too little, too late? This paper seems to suggest that time is running out, but that the centre is aware of the issues, and looking to play catch-up.

The paper, authored by Fuyuko Onishi, Yuichiro Hirai, Ryo Aruga, and Hidemi Bessho, can be downloaded here