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Australian Financial Markets

Introduction

This note brings together data on thevarious financial markets in Australia. It drawson surveys of foreign exchange and derivativesmarkets undertaken by the Bank last year aspart of world surveys of these marketscoordinated by the Bank for InternationalSettlements (BIS). It also makes use of datacollected by the Australian Financial MarketsAssociation (AFMA), the Australian StockExchange (ASX) and the Sydney FuturesExchange (SFE).

The markets cover foreign exchange, debtand equities, as well as their derivatives. Somekey inferences from the data follow.• Financial markets in Australia expanded

very rapidly in the 1980s, followingderegulation. They have continued to growin the 1990s, but at a pace more in linewith world financial markets.

• Relative to the size of the economy,Australian financial markets are large byinternational standards, and welldeveloped. While Australia ranks aroundfourteenth in the world in terms of GDP,many of its financial markets rank morehighly. By turnover, the foreign exchange

market, for example, ranks ninth in theworld, while turnover in exchange-tradedinterest rate futures and options contractsranks sixth. The main exception is thecorporate bond market, which remainslargely undeveloped.

• Activity in Australian financial markets isdirected mainly at meeting the needs ofthe domestic economy, in contrast tomarkets in London, Singapore andHong Kong, where most of the trading isinternational, rather than related to thedomestic economy.

• The dominant participants in Australianmarkets are banks, especially in foreignexchange and derivatives. As aconsequence, supervision of the bankingsystem carries with it the supervision of alarge part of the activity in financialmarkets.

The Foreign ExchangeMarket1

The Australian marketThe Australian foreign exchange market has

grown strongly since the early 1980s, in termsof trading in both Australian dollars and other

1. Previous articles on the Australian foreign exchange market appeared in the August 1987, March 1990 and May 1993issues of the Bulletin.

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currencies (see Graph 1). Two phases ofgrowth can be identified. Between 1985 and1990, the market grew very rapidly, withaverage daily turnover rising from a little over$A5 billion to $A44 billion, an average annualincrease of around 50 per cent. Growthpaused at the beginning of the 1990s as thefinancial system experienced a period ofconsolidation, but turnover picked up at amoderate pace from 1992. By 1995, turnoverhad reached around $A50 billion per day, anaverage annual increase of around 3 per centduring the five-year period.

Table 2 provides a breakdown of foreignexchange turnover in the Australian marketby type of transaction and counterparty. Spottransactions, which involve outright tradingof currencies for settlement within twobusiness days, are becoming a less prominentpart of market turnover. Spot transactions inAustralian dollars, for example, are now littlemore than half the peak level of the late 1980s.This reflects a maturing of the market and adecline in speculative activity. The maingrowth in the market has been in swapsactivity, which has reflected the general trendby market participants to make greater use ofderivatives in all markets. Swaps2 account forvirtually all the derivatives trading in theforeign exchange market. There is no futuresmarket in Australian dollars, and only minor

Table 1: Currency Composition ofForeign Exchange Turnover in

Australia(a)

April 1995(Per cent of

total turnover)

$A/US$ 42.0US$/German mark 21.7US$/Yen 13.3Pound sterling/US$ 7.0NZ$/US$ 3.2US$/Swiss franc 2.6

(a) Gross turnover (ie not adjusted for doublecounting)

Source: ‘Survey of Foreign Exchange MarketActivity in Australia’, Reserve Bank ofAustralia Media Release, September 1995.

1986 1988 1990 1992 1994 19960

10

20

30

40

0

10

20

30

40

Foreign Exchange TurnoverDaily average

US$B

All currrencies

US$B

$A

Other

Graph 1

Several factors have contributed to thisgrowth. The deregulation of Australianmarkets – specifically the floating of theexchange rate and the removal of exchangecontrols – was the major factor in the mid tolate 1980s. Following that burst in activity,the expansion of the Australian foreignexchange market has been driven largely bythe growth in global foreign exchange trading.

In recent years, Australia has becomeincreasingly integrated into the global foreignexchange market, helping to bridge the timegap between the close of the New York marketand the opening of the major Asian marketsof Tokyo, Hong Kong and Singapore. Tradein currencies other than the Australian dollar

has increased strongly and now exceeds tradein the Australian dollar. In 1995, average dailyturnover in the Australian dollar was around$A24 billion, while third currency turnoverwas around $A27 billion per day. Table 1shows the main currency pairs traded in theAustralian market.

2. Transactions in which parties agree to exchange two currencies and to reverse the exchange at a later date.

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trading in outright forwards3 and options.4

This is not dissimilar to patterns of tradingelsewhere in the world.

As in all ‘over-the-counter’ markets,customer-based business in the foreignexchange market is only a small part of totalturnover; it has typically averaged around20 per cent of the total. Most turnover is whatis often referred to as ‘inter-dealer’, whichinvolves dealers transacting currencies amongthemselves to lay off positions resulting fromcustomer deals and to determine the exchangerate at each point in time. In Australia, anincreased proportion of this inter-dealertrading is with dealers in other countries,reflecting the growing importance of tradingin currencies other than the Australian dollar.

Foreign exchange has been a market where,traditionally, a large proportion of deals havebeen executed through brokers. In recent

years, however, there appears to have beensome move away from use of brokers;transactions through brokers have declined toabout 25 per cent of total turnover, comparedwith about one-third in the late 1980s. Greateruse of electronic deal-matching services is onereason for this.

Over 70 foreign exchange dealers operatein the Australian market but turnover hasalways been fairly concentrated and hasbecome even more so over the past few years.The top 10 dealers now account for around70 per cent of turnover, compared witharound 60 per cent at the end of the 1980s.Most of these top 10 dealers are banks. Whilenon-banks comprise just under half of the totalnumber of foreign exchange dealers, theirshare of turnover is only one-eighth of themarket.

Table 2: Australian Foreign Exchange Market ActivityAverage Daily Turnover(a)

(US$ billion)

April 1989 April 1992 April 1995

By type of transactionOutright spot 18.0 12.6 17.6– of which against $A 9.1 3.5 5.6Outright forward 1.5 1.2 1.3– of which against $A 1.1 0.7 0.8Swaps 9.4 15.1 20.6– of which against $A 5.7 7.4 10.0By type of counterpartyWith customers 6.1 5.8 9.0With other resident dealers 7.5 5.6 8.0With overseas banks 15.2 17.6 22.5Total 28.9 29.0 39.5– of which transactions through brokers 9.7 9.4 9.8

(a) Adjusted for double counting. Items may not sum to totals due to rounding.

Source: ‘Survey of Foreign Exchange Market Activity in Australia’, Reserve Bank of Australia Media Release,September 1995.

3. Exchange of two currencies for settlement more than two business days after the conclusion of the deal.

4. General articles on derivatives, their role and risks appeared in the August 1993 and May 1995 issues of theBulletin. The results of a Reserve Bank questionnaire on the derivatives activities of Australian banks were publishedin the September 1994 issue of the Bulletin.

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The global contextThe Australian foreign exchange market

accounts for around 2.5 per cent of worldturnover, ranking ninth among world tradingcentres (see Table 3). The UK, US and Japanare the three largest foreign exchange markets;between them they accounted for around55 per cent of total turnover in April 1995.

The US dollar clearly remains the dominantcurrency in global foreign exchange trading,being involved in over 80 per cent oftransactions (see Table 4). There is then asubstantial drop to the German mark and theyen. Interestingly, turnover in many Europeancurrencies has risen relative to othercurrencies over the past three years; the shareof the French franc in turnover, for example,has doubled. The wider fluctuation bands inthe European Exchange Rate Mechanismsince August 1993 was an important factorhere, allowing more volatility in theseexchange rates.

The latest BIS survey of world foreignexchange trading identified the Australiandollar as the world’s eighth most traded

currency. This is up one place from its rankingin the previous survey in April 1992,displacing the ECU. A large proportion of thetrade in Australian dollars is conductedoutside Australia. Around 40 per cent ofglobal Australian dollar trade is conducted inAustralia; the rest is conducted in other(Asian, European and US) markets. In theprevious survey around 45 per cent ofAustralian dollar trade was in the Australianmarket. The change reflects the growinginterest by international fund managers inholding Australian-dollar investments.Australian dollar-denominated securities arenow represented in most world capital marketindexes, which tends to stimulate activity inAustralian-dollar transactions among theseinvestors. This tendency for a large proportionof turnover to take place outside the countryof issue is not unusual. Only about 16 per centof global turnover in US dollars, for example,occurs in the US; 10 per cent of German marktrading occurs in Germany; and 35 per centof yen trading occurs in Japan.

Table 3: Foreign Exchange Turnover(a)

April 1995 Per centTurnover change

(US$ billion sinceper day) April 1992

United Kingdom 463.8 60United States 244.4 46Japan 161.3 34Singapore 105.4 43Hong Kong 90.2 49Switzerland 86.5 32Germany 76.2 39France 58.0 74Australia 39.5 37Denmark 30.5 15Canada 29.8 36Belgium 28.1 79

(a) Turnover adjusted for local double counting.

Source: ‘Central Bank Survey of Foreign ExchangeMarket Activity in April 1995’, Bank forInternational Settlements PressCommuniqué, October 1995.

Table 4: Share of Selected Currenciesin Global Turnover

(Per cent of total)(a)

April 1992 April 1995

US dollar 82 83German mark 40 37Japanese yen 23 24Pound sterling 14 10French franc 4 8Swiss franc 9 7Canadian dollar 3 3Australian dollar 2 3ECU 3 2Other EMS 9 13

(a) Refers to the use of the currency as one side of atransaction, based on gross turnover (ie notadjusted for double counting). Relative shares canbe calculated by dividing each number by 2.

Source: ‘Central Bank Survey of Foreign ExchangeMarket Activity in April 1995’, Bankfor International Settlements PressCommuniqué, October 1995.

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The Debt Markets

As with the foreign exchange market, debtmarkets in Australia expanded markedlyduring the 1980s following deregulation. Atthe short end, the debt market encompassesthe markets for short-term bank securities(bank bills and negotiable certificates ofdeposit), Treasury notes, and StateGovernment and private commercial paper.Long-term debt markets are dominated byCommonwealth and State Governmentbonds. Corporate bonds and mortgage-backed securities make up the remainder butthese markets have tended to be small.Markets for interest rate derivatives are verywell developed.

Table 5 uses a variety of sources to providea broad indication of the structure of theAustralian debt market.

Long-term debt securitiesThe most active securities markets are those

for Commonwealth and State Governmentsecurities. Turnover in these markets, notsurprisingly, is closely related to the level ofoutstanding debt. This is illustrated in thecase of Commonwealth GovernmentSecurities (CGS) in Graph 2. During theperiod of consolidation in the CommonwealthGovernment budget during the late 1980s,turnover declined along with the level ofoutstanding CGS. Since 1990/91, however,both bond outstandings and turnover haverisen sharply.

Table 5: Average Daily Turnover inDebt Markets

1994/95

Short-term securities $A billionBank securities 1.6Treasury notes 0.3(a)

Commercial paper 0.8Long-term securities(b)

Commonwealth bonds 7.8State Government bonds 2.9Corporate bonds 0.1(a)

Indexed bonds 0.1(a)

Interest rate derivatives(notional turnover)

Exchange traded 27.7Over the counter 3.8(c)

(a) Derived from 1995 Australian Financial MarketsReport, Australian Financial MarketsAssociation.

(b) Includes repurchase agreements.

(c) From ‘Central Bank Survey of Derivatives MarketActivity’, Bank for International Settlements PressCommuniqué, December 1995; figure for April1995.

85/86 87/88 89/90 91/92 93/94 95/96*0

20

40

60

80

0

2

4

6

8

Market for CGS$B

* As at end March 1996.

Average daily turnover(RHS)

$B

Bonds on issue(LHS)

Market trading has also been helped byinitiatives taken by the Commonwealth toimprove the structure of its debt on issue.Particularly important have been the stepstaken to consolidate the debt into a relativelysmall number of ‘benchmark’ series of bonds.5

In 1985, the Commonwealth had 153different series of bonds on issue, each serieswith an average amount on issue of$300 million. The number of series of bondson issue has now been reduced to 51. Withinthis, there are 20 benchmark bonds, each withabout $4-5 billion on issue. Benchmark seriesnow account for about 97 per cent of the totalvalue of bonds on issue, compared with30 per cent in the late 1980s. These steps havehelped promote market liquidity; as can be

Graph 2

5. See Budget Related Paper No. 1, ‘Government Securities on Issue’, for a full description.

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The trend towards consolidation of debt wasled by the State Government authorities,which began to establish specialist borrowingauthorities in the mid 1980s. These proved tobe very successful in improving the liquidityof these markets, so that by the early 1990sturnover in State Government bondsexceeded that in CGS. Since then, in contrastto the sharp expansion in CGS turnover,turnover in State Government securities hasdeclined a little, due mainly to falls in amountson issue as State Government borrowingrequirements have fallen. As shown in Table 5above, the turnover in semi-governmentsecurities is less than half that in CGS.

A particular feature of the Australian debtmarkets has been the absence of awell-developed corporate bond market.Various reasons have been advanced for this,including Australia’s high inflation during the1970s and 1980s, which tended to discourageborrowers from entering into long-termborrowing commitments. A large amount ofcorporate funding, for example, wasundertaken through short-term bills. To theextent that corporations issued bonds, theytended to do so in offshore markets. Theeuro-$A market has at times been very large –for example, in the late 1980s when there was

strong demand for these bonds by overseasinvestors because of the high interest rates onoffer. Outstanding corporate bonds have beenin decline since early 1993, and turnovertypically averages only $100 million a day.Outstanding $A eurobonds issued bycorporates have been increasing over muchof the same period.

Indexed bonds are a relatively new market.This market is dominated by Commonwealthand State issues, but also incorporates a smallbut expanding market for corporate andasset-backed indexed bonds. Increasingly,indexed bonds are being incorporated in bondperformance indexes, which has made themmore attractive to institutional investors whoseperformance is judged against those indexes.At the end of 1995, there were around$9 billion of indexed bonds outstanding, withturnover estimated at around $80 million perday.

Another development in long-term debtmarkets in recent years has been an increasein the use of repurchase agreements – the saleof a security with a simultaneous agreementto reverse the transaction at an agreed priceon an agreed date. Repurchase agreements areused for two purposes. The first is as a vehiclefor funding bond portfolios – a dealer with aportfolio of bonds can fund those bonds byselling them under repurchase agreements.Funding by this means is regarded by lendersas more secure than an outright loan (becausethe lender has a claim on the bonds in theevent of default) so the interest rate is usuallyless than on an outright loan. Repurchaseagreements therefore provide a cost-effectiveform of funding for bond dealers. Secondly,repurchase agreements are used by dealers toborrow and lend bonds as a way of bridginggaps in their bond portfolios. Accurate figureson turnover in repurchase agreements are notavailable, but turnover in repurchaseagreements involving CGS is estimated toaverage $5-6 billion a day.

As with the foreign exchange market,inter-dealer trading in debt markets accountsfor a large proportion of turnover. Around55 per cent of turnover in the outright fixedinterest market and around 80 per cent of

seen in Graph 3, annual turnover in bonds,as a proportion of bonds on issue, is now muchhigher than in the late 1980s, beforebenchmarking began.

85/86 87/88 89/90 91/92 93/94 95/96*0

30

60

0

10

20

Velocity of CGS Turnover$B

* As at end March 1996.

Velocity of turnover(RHS)

Times

Bonds on issue(LHS)

Graph 3

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repurchase agreements are transactedbetween professional market participants. Themarket is not quite as concentrated as theforeign exchange market, with the top10 dealers (half of which are banks)accounting for 50 per cent of turnover(compared with 70 per cent in the foreignexchange market).

No recent international comparison of bondturnover is available, but data from JP Morganindicate that, in 1991, Australian bondturnover ranked twelfth in the world.

Short-term debt securitiesThe market for short-term debt securities

– comprised largely of bank bills andnegotiable certificates of deposit – has beengoing against the trend of other markets inrecent years, with turnover tending to decline.This trend reflects historical developments. Inthe 1980s, trading in bank bills in Australiaincreased rapidly in response to the StatutoryReserve Deposit (SRD) requirement onbanks. To avoid the SRD impost, banksarranged a large proportion of their loansthrough bank bills, which did not requireSRDs to be held against them. At their peakin 1990, bank bills on issue amounted tonearly $70 billion, or close to 30 per cent ofbank credit outstanding. Turnover in bills wasthe major activity in the money market.Following the replacement of SRDs in 1988with non-callable deposits, this market beganto decline.

Since their 1990 peak, bank billsoutstanding have fallen by about 12 per centto around $61 billion. Turnover has fallenmore markedly, by about a third, over the sameperiod. Since 1994, turnover has been stableat about $1 billion per day. Most of thisactivity appears to reflect issue andredemption; little secondary market tradingis occurring.

While bank bills have declined since 1990,the stock of negotiable certificates of deposithas increased, to about $35 billion. Turnoverin certificates of deposit is about $0.7 billionper day.

The decline in turnover in the short-termdebt market was reinforced by two otherfactors. First, short-term interest rate volatilityhas declined over the 1990s, in large part as aconsequence of the Reserve Bank’s practicesince January 1990 of announcing a target forthe cash rate, although lower inflation inAustralia and lower exchange rate volatilityhave also played a role. Secondly, some of theliquidity trading which occurred previously inshort-term securities now occurs usingrepurchase agreements secured bylonger-term securities. For example, themajority of the Reserve Bank’s money markettransactions for liquidity management are nowconducted using repurchase agreements,rather than outright purchases and sales ofshort-term CGS.

Unlike the long-term debt markets, less than20 per cent of transactions in the short-termmarket are among professional marketparticipants. Corporates and fund managerstend to transact a relatively large proportionof business in the short-term market, giventhat they use these securities to meet theirshort-term investment needs.

Derivatives marketMarkets in interest rate derivatives, both

over-the-counter (OTC) and exchangetraded, are very active. Table 6 shows types ofinterest rate derivatives by outstandings andturnover in April 1995.

As in the case of foreign exchangederivatives, most of the activity is in relativelysimple products like swaps and futures. Wellover half of the outstandings are OTCderivatives,6 but most of the turnover is inexchange traded futures contracts.

Trading in interest rate derivatives hasoccurred on the Sydney FuturesExchange (SFE) since 1979, making theSFE the first exchange outside theUnited States to trade interest rate futurescontracts. Since then, the interest ratederivatives market has expanded rapidly. Interms of notional value, contracts valued ataround $7,000 billion were traded on the SFE

6. According to Table 6, around 60 per cent. But the actual proportion is probably higher because these data onexchange traded derivatives are not adjusted for double counting.

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in 1994/95 (an average of around $28 billionper day).7 This is roughly double the turnoverfive years earlier. Three-quarters of this tradewas in bank bill contracts, with the remaindershared between 3-year and 10-year bondcontracts. Most trade in interest ratederivatives is in futures contracts, with optionsmaking up only 10 per cent of turnover.

As in the physical market, turnover in theinterest rate futures market is affected byvolatility and uncertainty in interest rates. Forexample, turnover jumped sharply in the late1980s and again in 1994 in an environmentof rising interest rates. In the more stableinterest rate environment of the second halfof 1995, turnover dropped back significantly.

According to the BIS survey of worldderivatives markets, Australia had the sixthlargest turnover of exchange-traded interestrate derivatives in the world in April 1995 –behind only Japan, the United Kingdom, theUnited States, France and Germany. Tradein OTC interest rate derivatives, however, issmall relative to other countries. The BISsurvey ranks Australia equal twelfth in theworld in OTC markets. Two-thirds of this

turnover is in the form of forward rateagreements. Around 80 per cent of OTCturnover is undertaken by banks.

The Equity Market

Market capitalisation and turnoverLike most other financial markets, turnover

on the Australian Stock Exchange (ASX) hasgrown strongly over the past 10 years (seeGraph 4). In 1995, turnover was a record$A133 billion, or $0.5 billion a day. This wasmore than double its level three years earlier.Market capitalisation at the end of 1995 was$546 billion, more than five times that of10 years earlier. Most of this has come froman increase in the value of companies listed,as the number of companies listed hasincreased only modestly, from 1,034 to 1,179.

The globalisation of financial markets hasseen an increasing foreign presence in theAustralian equity market. There are currently

Table 6: Interest Rate Derivatives – Australia(US$ billion)

Nominal or notional principal amounts

Outstandings Turnoverend March 1995 April 1995

(Daily average)

Forward rate agreements 88.7 2.0Swaps 231.9 0.5OTC options 25.3 0.3Exchange traded options(a) 45.3 3.2Futures(a) 206.0 31.3Other products 0.4 —

Total 597.6 37.3

(a) Not adjusted for local dealer double counting.

Source: ‘Survey of Derivatives Market Activity in Australia’, Reserve Bank of Australia Media Release,December 1995.

7. These data from the SFE are adjusted for double counting. Data presented in this discussion capture onlytransactions on the SFE, while data from the BIS survey, presented in Table 6, are based on transactions byAustralian institutions on both the SFE and overseas exchanges.

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1985 1987 1989 1991 1993 19950

100

200

300

400

500

0

100

200

300

400

500

Average Daily Equities Turnover

$M $M

Graph 4 49 foreign companies listed on the ASX, witha total capitalisation of $217 billion; thiscompares with 18 companies with acapitalisation of $15 billion in 1985. The roleof foreign investors in the Australian markethas also increased in recent years. Foreigninvestors accounted for a quarter of totaltrading on the ASX in 1994/95, up from justover 18 per cent a decade earlier. Most foreigninvestment originates from the US and UK,although investors from Hong Kong are alsoquite active in the Australian market. In termsof share ownership, foreign investors anddomestic institutional investors eachaccounted for 32 per cent of the Australian

Table 7: Turnover, Liquidity and Capitalisation of Domestic Equities – 1995(a)

Annual Market Ratio of turnoverturnover capitalisation(b) to capitalisation

($A billion) ($A billion) (Per cent)

United States(c) 7,126 9,451 75Japan(d) 1,111 4,744 23Germany 814 776 105United Kingdom 688 1,884 37Taiwan 511 251 204Switzerland 409 533 77France 282 667 42Korea 249 240 104Canada(e) 210 493 42Netherlands 169 384 44Hong Kong 143 410 35Australia 133 330 40Italy 128 275 46Sweden 117 230 51Spain(f) 70 255 27Denmark 37 75 49Norway 33 60 56Finland 26 59 44Belgium 21 136 15Austria 18 41 43Greece 8 22 37

(a) Does not include foreign companies listed on domestic exchanges.(b) At end 1995.(c) New York, Nasdaq and American exchanges.(d) Tokyo exchange.(e) Toronto exchange.(f) Madrid exchange.Source: Fact Book 1996, London Stock Exchange.

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equity market in June 1995; domestic privateinvestors accounted for a further 23 per cent.

Ownership of shares by individuals hasincreased significantly in recent years, and by1994 around 21 per cent of all adults ownedshares. Australia has moved from having oneof the lowest rates in the world to a levelcomparable with other developed countries(in the US, 25 per cent of adults own shares;in the UK, about 22 per cent; and in Japan,about 24 per cent). Three-quarters of theseindividuals own shares directly, while theremainder own them through units inmanaged equity and listed property trusts.

The global contextTable 7 summarises data on turnover,

liquidity and market capitalisation for themain equity markets in 1995.

In terms of turnover, the ranking of theAustralian market has not changed much inrecent years. In 1995, the Australian marketwas the ninth most active in the OECD area.The Australian market also ranked ninth inthe OECD in terms of market capitalisation.

Among Asian markets, however, theAustralian market has the third highestcapitalisation (after Japan and Hong Kong)but ranks fifth in terms of turnover. In otherwords, there is a greater degree of stability inshareholdings in Australia than in some ofthe Asian markets. Annual turnover in 1995,

for example, was 40 per cent of marketcapitalisation, whereas in Taiwan thecorresponding figure was around200 per cent.

Equity derivativesEquity derivatives in Australia are traded on

the SFE and ASX Derivatives (ASXD), asubsidiary of the ASX. ASXD, under itsoriginal title of the Australian Options Market,was established in 1976 and was the firstoptions exchange to be established outsideNorth America. The SFE has the higherturnover in equity derivatives of the twoexchanges. It trades 10 individual equityfutures, as well as Share Price Index (SPI)futures and options based on the AllOrdinaries Index. Trading in these contractsreached $163 billion during 1995, making itlarger than the turnover in physical shares.Trading in Share Price Index futuresaccounted for 77 per cent of this.

ASXD currently lists options on a varietyof shares, for a range of maturities. Turnoveron ASXD was $A77 billion in 1995,equivalent to about 60 per cent of turnoverin physical equities. ASXD is estimated tohave been the eighth largest equity optionsmarket measured in terms of turnover in 1995,following the four major American equityoptions exchanges and three Europeanexchanges.