Speech
Australia’s External Position and the Evolution of the FX Markets
Christopher Kent
*
Assistant Governor (Financial Markets)
Address to Australian Financial Markets Association/Bloomberg
Sydney
–
29 April 2025
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Watch video: Speech by Christopher Kent, Assistant Governor (Financial Markets), to Australian Financial Markets Association/Bloomberg.
Introduction
I would like to thank Bloomberg for hosting this event. Today I will discuss Australia’s evolving
external position and the development of foreign exchange (FX) markets. 1
I will emphasise the growing footprint of superannuation funds in Australia’s capital flows and the importance of these and other
‘buy-side’ firms of adopting best practices in FX markets. 2
Australia’s capital account and FX markets since the float
The removal of capital account restrictions and the floating of the Australian dollar in 1983 reshaped our
economy. Free capital movement facilitated large increases in foreign investment in Australia and allowed
Australian households and firms to diversify their portfolios by investing overseas. Deep,
well-functioning FX markets that developed following the float helped banks, businesses and fund managers
to manage their foreign exposures.
Australia’s integration into global capital markets saw two distinct trends in our net investment
position with the rest of the world (Graph 1). First, in the decades after the float,
Australia’s high investment rate was associated with rising foreign debt. This saw net foreign
liabilities rise substantially to around 50 per cent of GDP. Second, over more recent years,
outbound investment has grown as a share of GDP as Australia’s saving rate rose and domestic
investment declined. This accumulation of foreign assets has contributed to an extraordinary decline in
Australia’s net foreign liabilities to levels last seen prior to 1983.
Graph 1
The rise in external debt and the internationalisation of FX markets in the 1980s
While foreign ownership of Australian assets was already common in some sectors, the full opening of the
capital account allowed for much more foreign investment in Australia. The growth in debt held by
overseas creditors was particularly noticeable in domestic banking and resource sectors. 3
The increase in cross-border investment was accompanied by a rise in FX transactions. Prior to the float,
spot transactions by local commercial banks dominated FX transactions. 4
While the Australian dollar spot
market grew strongly, the 1980s also saw the establishment of FX swap markets. These instruments, which
allowed market participants to better hedge their foreign currency exposures, quickly became the most
traded in Australian dollar markets (Graph 2). The deepening of FX markets locally was also
supported by the Australian Government’s steps to broaden foreign banks’ participation in
Australia’s markets. 5
Graph 2
The growth of currency markets enabled non-financial corporations to make use of hedges in support of
their trade flows and foreign-currency borrowing. 6
This hedging was in part a response to post-float
currency volatility and high-profile losses by unhedged borrowers. 7
Over the 1980s, both the share of
firms hedging and the average share of currency exposures hedged increased significantly.
By the mid-1990s, the internationalisation of the Australian dollar and its capital markets was well
advanced. Trading in Australian dollar FX derivatives had risen to $75 billion per day, with about
60 per cent undertaken offshore. 8
Also, foreign entities were issuing debt in Australian
dollars in the ‘Kangaroo bond market’. 9
This issuance grew steadily over the 2000s, supported by
cross-currency basis swaps, another FX derivative but with longer tenors that enabled better hedging of
long-lived foreign currency borrowings. 10
Rising demand for Australian dollar assets from international investors enabled Australian businesses to
issue debt in Australian dollars. 11
At the same time, Australian banks and businesses
issuing in large offshore markets could hedge their foreign currency-denominated debt back into
Australian dollars at a modest cost. Both developments greatly reduced the vulnerability of Australian
debtors to Australian dollar depreciation.
The growth in Australian dollar FX markets since the float has been remarkable: it is the sixth most
traded currency, even though Australia ranks 13th in economic size. 12
This demonstrates the importance
to Australia of FX markets in support of foreign trade and investment. But it also reflects the
attractive correlations of the Australian economy (and hence the Australian dollar) with economic
developments in Asia, coupled with strong institutional settings in Australia, including the free
movement of capital.
The increasing role of superannuation funds in Australia’s FX markets
Another key facet of Australia’s external position has been the substantial growth of the net foreign
equity position. Australians have steadily accumulated more foreign equity holdings than foreigners have
accumulated in Australian equity. Indeed, since 2013 we have had a positive net equity asset position
(Graph 3).
Graph 3
The rise in net equity assets of late has occurred while Australia has been running a current account
deficit, creating an unusual situation. Inflows of new liabilities rose with the banks returning to
offshore debt markets as the RBA’s Term Funding Facility came to an end. However, a further rise in
foreign equity holdings offset this, so net liabilities still declined. Much of the rise in net foreign
equities reflects valuation effects from the Australian dollar’s depreciation and rising overseas
equity values (Graph 4). 13
Even so, new equity accumulation continues, driven by
investment from Australia’s superannuation funds.
Graph 4
The growth of superannuation funds since 1993 and their rising offshore investments have significantly
shaped Australia’s balance of payments. Super funds’ offshore asset allocation has increased
from nearly one-third in 2013 to about half in 2024 (Graph 5). As a result, super funds now account
for a substantial share of Australia’s capital outflows.
Graph 5
Purchases of foreign currency assets by superannuation funds expose them to exchange rate fluctuations.
Many funds shield their members by partially hedging the foreign exchange rate risk associated with
offshore assets via, for example, FX swaps. Given the large increase in super funds’ offshore
assets, the extent of foreign currency assets hedged has more than quadrupled since 2013. 14
This
has made the super funds natural counterparties to domestic banks, which are hedging their FX exposures
arising from issuing debt offshore in foreign currency terms.
The Foreign Exchange Global Code
This discussion highlights the increasing role of superannuation funds and their asset managers in FX
markets. For FX markets to meet participants’ needs, it is important that they all observe
common standards promoting fair and transparent markets. The Foreign Exchange Global Code (Code)
fulfills that function.
With the advent of the Code in 2017, buy-side participants like super funds can have greater
confidence in market functioning and the behaviour of their sell-side counterparties. But this is a
two-way street: both sell-side and buy-side firms should adhere to the Code’s standards.
Moreover, one way for fund managers to demonstrate that they are meeting their fiduciary duties is to
adhere to the Code. Encouraging more buy-side participants to sign up is a focus of the Global
Foreign Exchange Committee (GFXC).
To this end, the GFXC has worked hard to explain the process of signing up to the Code. We have
emphasised that adoptees can concentrate on those aspects of the Code that are material to their
activities, thereby greatly reducing the burden for buy-side firms.
I will end by acknowledging the sharp rise in volatility in FX markets in early April as markets
incorporated announcements about the US administration’s tariffs and the subsequent ebb and flow
of related news. The Australian dollar fluctuated within a range of US4 cents, experiencing its
largest daily decline of 4.5 per cent against the US dollar outside of the global
financial crisis. Also, measures of volatility from FX options increased to levels observed during
the pandemic and liquidity deteriorated noticeably. While markets have been more settled of late,
such episodes serve as a reminder of the importance of the Code. It enhances trust between market
participants and offers standardised and predictable ways of doing business. Hence, the role the Code
plays in proper market functioning is even more crucial during periods of great uncertainty when
markets are adjusting to significant economic news.
Endnotes
I thank George Tyler, Jason Griffin and Marcus
Miller for their great assistance in helping me to prepare this speech.
*
This work builds on previous RBA work including
Smith P (2023), ‘
The Extraordinary Decline in
Australia’s Net Foreign Liabilities
’, Speech at the CFA Societies 2023
Australian Investment Conference, Sydney, 18 October; Debelle G (2019), ‘
A Balance of Payments
’, Address to the
Economic Society of Australia, Canberra, 27 August. 1
‘Buy-side’ institutions purchase
currency to invest in international assets; they include hedge funds, insurance firms, pension
funds, and other asset managers. ‘Sell-side’ institutions – typically banks and
currency brokers – trade currency with buy-side firms and provide liquidity in FX markets. 2
Tease W (1990), ‘
The Balance of Payments
’, in
The
Australian Macro-economy in the 1980s
, RBA Annual Conference,
20–21
June; Black S, J Kirkwood, A Rai and T Williams
(2012), ‘
A History of Australian Corporate
Bonds
’, RBA Research Discussion Paper No 2012-09. 3
Though a small market for non-deliverable
forwards did exist prior to the float: Caballero RJ, K Cowan and J Kearns (2004), ‘
Fear of Sudden Stops: Lessons from Australia and
Chile
’, RBA Research Discussion Paper No 2004-03. 4
Fraser B (1994), ‘
Foreign Banks in Australia
’,
Talk to the Overseas Banks’ Association of Australia, Melbourne, 17 August; Debelle G
(2006), ‘
The Australian Foreign Exchange
Market
’, Speech at Insto’s Foreign Exchange Conference, Sydney,
17 November. 5
Debelle, n 5. 6
Becker C and D Fabbro (2006), ‘
Limiting Foreign Exchange Exposure through Hedging:
The Australian Experience
’, RBA Research Discussion Paper No 2006-09; James E and C
Vallence (2020), ‘
The Road to
Australian Dollar Funding
’, RBA
Bulletin
, March. In this episode,
numerous borrowers incurred significant losses on unhedged liabilities denominated in Swiss
francs, which encouraged a more sophisticated approach to foreign financing thereafter. 7
This rose further over time and was around
85 per cent in 2013. See Bank for International Settlements (1998), ‘Triennial
Central Bank Survey of Foreign Exchange and Derivatives Market Activity’, May. 8
Debelle G (2008), ‘
Recent Developments in the Australian Bond
Market
’, Address to the Westpac/KangaNews Speed-meeting Summit: Kangaroos &
Kauris, Sydney, 5 March. 9
Ryan C (2007), ‘
Some General Observations on the Kangaroo Bond
Market
’, Address to the Kangaroos: Positioned for Growth Conference, Sydney,
29 March. 10
Black
et al
, n 3. 11
Bank for International Settlements (2022),
‘Triennial Central Bank Survey: OTC Foreign Exchange Turnover in April 2022’,
27 October. For GDP (current prices) data in 2022, see the International Monetary Fund World
Economic Outlook Database. 12
This is in fact not a new phenomenon for
equities: since 2013, valuation changes have been the driver of declines in the net foreign
equity position, rather than new transactions. This reflects the comparatively greater returns
generated by US equities, the long-run depreciation of the Australian dollar, and the offsetting
effect of foreign direct investment in Australian equities. 13
Over recent years, the hedge ratio of offshore
assets has declined sharply. While motivations and strategy vary by firm, there are likely to be
several contributing factors to this decline, including economising on carry costs associated
with hedging transactions and the use of a lower currency hedge ratio as a tail-risk hedge
against declines in US equities. 14