NEW YORK, June 20 (Reuters) - Foreign-exchange investors are moving more of their over-the-counter (OTC) derivatives trades to lookalike products on e
NEW YORK, June 20 (Reuters) – Foreign-exchange investors
are moving more of their over-the-counter (OTC) derivatives
trades to lookalike products on exchanges to avoid higher costs
due to recent global regulations, helping inject transparency
into a multitrillion-dollar market that is largely hidden from
the public eye.
The growing interest in clearing trades through an exchange
comes as regulations capture more users of these contracts,
bolstering the need to shift away from bilateral trading and
manage rising compliance cost.
“There is more transparency, lower margin requirement
overall (in trading listed products), which is a benefit for
asset managers and hedge funds in leveraging their positions,”
said Ben Feuer, head of FX trading and head of sales trading at
Societe Generale in New York.
The gradual behavioral change in FX derivatives trading is
being caused by increasing margin and collateral costs, said Joe
Midmore, chief commercial officer at OpenGamma, a derivatives
analytics firm.
Effective September 2022, buy-side firms with uncleared OTC
derivatives totaling at least $8 billion are subject to the
regulations – set by the Basel Committee on Banking Supervision
and the International Organization of Securities Commissions –
and have to ensure there is enough margin to cover the risk of a
default by a counterparty to the transaction.
OTC derivatives are privately negotiated contracts while
cleared derivatives, though bilaterally negotiated, are booked
with a clearinghouse such as a listed exchange. The new margin
rules exempt cleared trades.
Higher interest rates make posting margin more expensive.
“Lots of exchange salespeople have been going out to
investors for a long time saying ‘look at how much more
efficient trading in listed futures is,’ but it didn’t matter
until now when interest rates are 5% instead of zero,” said
Michael Riddle, CEO at Eris Innovations which partners with the
CME Group and other exchanges to develop futures and
options products.
The shift is most acute for buy-side firms that have to post
margin for the first time, said Paul Houston, head of FX markets
at CME Group.
“They will also incur the operational, legal and custody
costs of setting up margin facilities as well as the capital
costs of posting margin,” Houston said.
CME’s listed FX futures and options market now trades an
average daily volume of $85 billion versus $76 billion in 2021,
indicating more investors are using exchange-traded derivatives
to replace OTC trades where possible.
That is still a fraction of the $7.5 trillion that trades
daily in the FX markets, the vast majority of which happens OTC.
British clearing house LCH’s ForexClear also had a record
May for FX options, surpassing $200 billion in notional value,
meaning the total value of a derivatives trade, for the first
time.
“For the buy-side, FX clearing materially lowers
counterparty risk, enables portfolio optimization and provides
operational benefits,” said James Pearson, head of ForexClear.
GROWING ACCEPTANCE
Some 60 firms started trading FX futures and options at the
CME Group for the first time this year, more than two-thirds of
which are buy-side clients, according to CME data. Last year,
300 firms were trading new instruments for the first time.
An estimated 775 firms came under the scope of the new rules
last September, according to ISDA.
Some clients of Record Financial Group, a specialist
currency and asset manager, were exploring listed alternatives
while others were adjusting their risk management programs to
“stay within or under the regulatory threshold,” said the firm’s
head of sales, Tom Arnold.
Joe Spiro, director of product management at Hazeltree, said
as a firm’s exposure grows more may have to adhere to the new
rules, widening the appeal for trading on exchanges.
Investors can also now transact on a relationship basis as
they do in the OTC space and access clearing.
For instance, some 274,000 contracts in privately negotiated
blocks and exchange-for-related-positions (EFRPs), products that
allow users to trade on a disclosed, relationship basis against
their liquidity providers and access clearing, were traded on
CME on March 8, up 23% from the previous record in December.
Client clearing of nondeliverable forwards at ForexClear for
January to May reached $261 billion, 58% higher than the
corresponding period in 2022.
Not all see the need to shift even with higher costs and not
all derivative products have a cleared alternative, which limits
broader adoption.
Exchange-traded futures contracts have a fixed settlement
date relative to OTC forwards, making them unattractive to some
investors, said Peter Vassallo, a portfolio manager for the
currencies team at BNP Paribas Asset Management.
There are also concerns that pushing more trades to the
clearinghouse will consolidate risk rather than reduce it.
“There is inherently risk involved in lots of people
transacting derivatives with each other,” said Riddle. “And
there is no model that removes all that risk, it only changes
where it is, but can mitigate it.”
(Reporting by Laura Matthews in New York
Additional reporting by Shankar Ramakrishnan in New York
Editing by Megan Davies and Matthew Lewis)
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