THE MARKET IS MADE UP OF AN INTERNATIONAL NETWORK OF DEALERS

The market consists of a limited number of major dealer institutions that are particularly active in foreign exchange, trading with customers and (more often) with each other.

Most,but not all, are commercial banks and investment banks.

These dealer institutions are geographically dispersed, located in numerous financial centers around the world. Wherever located, these institutions are linked to, and in close communication with, each other through telephones, computers, and other electronic means.

There are around 2,000 dealer institutions whose foreign exchange activities are covered by the Bank for International Settlements’ central bank survey, and who, essentially, make up the global foreign exchange market.A much smaller sub-set of those institutions account
for the bulk of trading and market-making activity. It is estimated that there are 100-200 market-making banks worldwide; major players are fewer than that.

At a time when there is much talk about an integrated world economy and “the global village,” the foreign exchange market comes closest to functioning in a truly global fashion, linking the various foreign exchange trading centers from around the world into a single, unified, cohesive, worldwide market. Foreign exchange trading takes place among dealers and other market professionals in a large number of individual financial centers—New York, Chicago, Los Angeles, London, Tokyo, Singapore, Frankfurt, Paris, Zurich, Milan, and many, many others. But no matter in which financial center a trade occurs, the same currencies,or rather,bank deposits denominated in the same currencies, are being bought and sold.

A foreign exchange dealer buying dollars in one of those markets actually is buying a dollar-denominated deposit in a bank located in the United States, or a claim of a bank abroad on a dollar deposit in a bank located in the United States. This holds true regardless of the location of the financial center at which the dollar deposit is purchased. Similarly, a dealer buying Deutsche marks, no matter where the purchase is made, actually is buying a mark deposit in a bank in Germany or a claim on a mark deposit in a bank in Germany. And so on for other currencies.

Each nation’s market has its own infrastructure. For foreign exchange market operations as well as for other matters, each country enforces its own laws, banking regulations, accounting rules, and tax code, and, as noted above, it operates its own payment and settlement systems. Thus, even in a global foreign exchange market with currencies traded on essentially the same terms simultaneously in many financial centers, there are different national financial systems and infrastructures through which transactions are executed, and within which currencies are held.

With access to all of the foreign exchange markets generally open to participants from all countries, and with vast amounts of market information transmitted simultaneously and almost instantly to dealers throughout the world, there is an enormous amount of cross border
foreign exchange trading among dealers as well as between dealers and their customers.

At any moment, the exchange rates of major currencies tend to be virtually identical in all of the financial centers where there is active trading. Rarely are there such substantial price differences among major centers as to provide major opportunities for arbitrage. In pricing, the various financial centers that are open for business and active at any one time are effectively integrated into a single market.

Accordingly, a bank in the United States is likely to trade foreign exchange at least as frequently with banks in London, Frankfurt, and other open foreign centers as with other banks in the United States. Surveys indicate that when major dealing institutions in the United States trade with other dealers, 58 percent of the transactions are with dealers located outside the United States. The United States is not unique in that respect. Dealer institutions in other major countries also report that more than half of their trades are with dealers that are across borders; dealers also use brokers located both domestically and abroad.