Derek, you've worked in foreign exchange for over 18 years and been at the heart of the business as it has successfully adapted to many exciting and rapid developments in technology and operations over that period. What do you see as the key challenges the industry faces today?
Having spent 16 years working in Paris and London globally running an FX Options and Structured Products for a French investment bank, and now having spent almost 2 ½ years running global Foreign Exchange for CME Group, I feel that I have a unique view on both the opportunities as well as the threats to the global FX market today. While this market has demonstrated tremendous growth rates over the past 10 years driven in large part by technology and electronic trading, the key challenge we now face is how to deliver sustainable growth rates in such challenging market conditions.
Probably the most important issue facing the global FX market is access to credit, which is the life blood of not only the Spot FX market, but even more critical to the Forwards, Swaps and FX Options markets. Without access to sufficient credit, FX market participants find that access to counterparties quickly constricts, leading to a decrease in global liquidity with the attendant widening of spreads and decreased depth of book. Prices become more volatile, and it becomes more difficult to enter and exit trades without moving markets.
Concern over counterparty risk is widespread throughout the industry, as illustrated in a recent poll. CME Group’s annual survey showed this concern growing among banks, which cite counterparty risk as their biggest worry when supplying e-pricing, up to 84 percent this year, from 72 percent last year. By contrast, only 16 percent regarded latency as a concern, down from 19 percent in 2007. So you see concerns shifting away from “how can I do business faster?” to “how can I do business more safely?”.
You're responsible for managing CME Group's global FX growth strategy and have been quoted in the past as saying that it's well positioned to further expand its reach in FX. Have any of your major growth plans been significantly disrupted due to the global economic crisis?
When you see the type of growth in a market like FX for the past five years, you can expect that there will be some pull back at some point in time. For example, CME’s cumulative average growth rate from 2003-2008 was 42 percent, with our average daily volume increasing nearly six-fold. But following the credit issues from the third quarter of 2008, business across the entire FX market slowed down, across both futures as well as the cash FX platforms. Coming off of record volume performances in June-September of 2008, there’s no denying that volumes are down in 2009, at CME as well as those of all our peers in the cash FX market.
But it’s instructive to compare the figures across the venues: while the first quarter of 2009 CME average daily volume was down 21 percent versus the first quarter of 2008, volumes in the cash FX market were down between 36 percent and 38 percent. So during this time of slowing volumes, our market share continues to grow. We credit the relative out performance to focusing on ensuring that our customers have the products and services they need when markets are difficult, and continue to work hard on innovations, which will diversify our offering.
The credit crunch has forced traders in many markets to re-evaluate bilateral credit exposure and encouraged them to seek efficiencies, leading to an exodus towards exchange-style venues that offer enhanced risk mitigation. Has this also been the case with investors looking to trade currency products at CME?
Customer feedback, research results and volume numbers support this notion. Quite simply, central counterparty clearing, by acting as the buyer to every seller and the seller to every buyer, significantly mitigates counterparty risk, and introduces enormous balance-sheet efficiencies by reducing participants’ reliance on bilateral credit arrangements, which frees up capital so that it can be put to work more effectively. When institutions are squeezed for credit and concerned about default, the security of a clearing structure that has never defaulted in 150 years can’t be underestimated. What is truly interesting about current market conditions, is how the OTC and exchange business models will develop over time, and what type of convergence you may see in these markets, which will be a driver for future growth in both segments of the global FX market.
Last year we published results from the first CME Global FX Market Study which indicated that counterparty risk had overtaken cost and latency as the key concern for many FX trading firms. Given recent credit constraints do the results of this years study continue to support that trend and other major findings from the previous one?
Yes – at the recent Euromoney Forex Forum in London in May 2009, an audience poll showed that counterparty credit was ‘a major concern’ for 83 percent of the audience, with just under half of the participants (48 percent) voting that they would pay a service to mitigate this risk.
In the most recent CME Group Annual FX Market Survey, banks cited counterparty risk as their biggest concern when supplying e-pricing, up to 84 percent from 72 percent last year. Only 16 percent regarded latency as a concern, down from 19 percent in 2007. When looking at systemic risk, most were concerned about a liquidity crunch at 43 percent. Interestingly, insolvency emerged as of nearly equal concern, up massively from 15 percent a year ago to 35 percent immediately prior to the Lehman Brothers insolvency. And at the same time worries regarding macro-economic problems fell from 30 percent to 14 percent; major e-systems failure dropped from 26 percent to 13 percent; and back office/settlement limitations retreated from 26 percent to 12 percent.
From the outset when the Exchange first offered currency futures in 1972, the products it provided were designed and tailored with the individual investor in mind. Is that still true today and how difficult has it been to develop and support a product mix that remains compelling and attractive to both Retail and Institutional customers?
A preponderance of our current volume comes from institutional and corporate participants, but we have always felt it critical to be able to support the needs of individual traders by providing them equal access to the institutional market on a level playing field. The result is that between $12-$15 billion a day of business is coming from retail traders. It’s worth bearing in mind that all participants in our markets, large or small, have access to the same prices, the same liquidity, the same fully-disclosed costs and the safety of central counterparty clearing. So, we already have an extremely dynamic retail presence in our liquidity pool on a daily basis.
But in an effort to serve this important client base even more dynamically, we launched our new “Forex E-Micro” contracts in March 2009, delivering all the benefits of our existing liquidity pool and counterparty risk mitigation benefits in a contract size that is even more accessible for the smaller retail player. These contracts are roughly 1/10th the size of our standard FX Futures contracts, cost about 1/10th the fee, and are quoted in interbank terms. There are six currency pairs: EUR/USD, USD/JPY, GBP/USD, USD/CAD, AUD/USD, USD/CHF. So far, we have been very pleased with the growth of the product, which has quickly gained traction with our existing customers, as well as helped us to draw in more retail FX traders looking for the many benefits on on-exchange FX trading.
What are the key advantages you think the regulated exchange market now has to offer Retail FX traders and investors?
All participants in CME Group’s FX futures market have access to the same prices, the same liquidity, the same fully-disclosed costs and the safety of central counterparty clearing. Within CME Clearing there is no distinction between the trades of the smallest participant and the largest global powerhouse. Centralised clearing ensures that individuals’ exposure to counterparty risk is virtually eliminated, and their positions are marked to market daily, giving them unparalleled insight into their risk as well as the surety and validity of the market prices of their outstanding positions.
Earlier this year CME launched a series of innovative smaller-sized FX contracts called Forex E-Micros. What prompted that launch and what feedback have you had from brokers, FCMs and the Retail trading community about this new product?
The response from the brokerage community has been very positive; we launched with the participation of three retail brokerages and two more have since come on board. We have been very pleased with the enthusiastic uptake: Average daily volume is currently around 5,500 contracts, with participation from 62 different Bank FCMs, Retail FCMs, Brokers, Small CTAs, Introducing Brokers, Retail Traders, and prop groups. And an added benefit was the adoption of these products as a kind of a live-trading training aide for new traders from all asset classes by some prop-trading arcades. They can acclimatise themselves to electronic futures trading at one-tenth the risk exposure.
Following the CBOT and Nymex mergers what steps will you be taking to improve the ability for participants in CME's interest-rate, commodities and equities markets to leverage their Globex connections to access foreign exchange risk management tools?
Cross-selling has been very much a part of CME Group’s strategy for some time now; in fact, the prospect of increasing the range and variety of asset classes available through the same platform was one of the key drivers of our merger strategy. This means that users of Globex have access to a variety of opportunities to cross-margin and engage in spreading strategies. This goes for geographical reach as well, such that, for example, Singapore-based traders on the Dubai Mercantile Exchange (of which CME Group owns 28 percent) can now look at managing their FX risk through CME Group FX futures; or equity investors looking for uncorrelated alpha can investigate our CBOT agricultural commodities.
CME Group has become a hugely influential force within the global FX market. Do you think the Exchange has a responsibility to try and improve the way the market operates?
This is essentially what we do. The history of CME Group is one that shows a consistent commitment to ensuring fair, accessible markets with products that meet the needs of all participants. Our track record shows that our major innovations, like the invention of financial futures (with the introduction of FX futures in 1972) lead to great efficiencies and, in turn, greater liquidity, tighter spreads and increased participation. Our challenge now is how to work closely with all market participants and market segments to ensure the most robust, secure, and safe FX market possible for both Futures as well as cash FX market participants.
Over the last few years there has been much debate about the benefits of a central counterparty clearing (CCP) facility for over-the-counter products. FXMarketSpace, CME's joint venture with Thomson Reuters was the first international, centrally cleared forex platform and a ground breaking one. Were you surprised that it was eventually forced to close?
The concept of FXMarketSpace was an innovative one and while we regret its closure, we believe in innovation and the need to take business risks to move the markets forward. Our experience with FXMS has helped us learn a lot about the OTC FX space, as well as develop relationships across a broad array of market participants in this important market segment. One key factor to bear in mind is that current conversations across the rates and CDS spaces all centre on post-trade clearing facilities – in other words, leveraging the benefits of central counterparty clearing for these OTC markets – and not on providing execution and price-discovery facilities, which participants tell us are working well in the OTC space. We can take on clearing the more standardised, vanilla products, but we know that the more flexible, bespoke OTC-style transactions don’t lend themselves to mass processing and are best handled by the experts on the OTC desks.
Do you see the race to launch a CCP facility for over-the-counter products gathering pace once again and what role could CME play in helping to kick-start this process?
We see this process unfolding rapidly in the CDS space, with exchanges, regulators, dealers and investors all wishing to ensure that the market achieves new levels of safety and transparency. We have our own offering in the CDS race and are in talks with key dealers to encourage their participation, but what is most interesting about CME Group’s OTC clearing offering is the ClearPort platform that we acquired as part of the NYMEX merger. ClearPort was launched in May 2002 to clear energy products in the wake of the Enron bankruptcy and is now clearing more than 600 OTC products from the energy, gas, electricity and, increasingly, agricultural markets. Its average daily volume in the first quarter of 2009 was up 39 percent against the same quarter last year. It’s a flexible, market-driven solution which we anticipate will be at the centre of our OTC clearing initiatives going forward.
As a result of the global economic crisis some commentators believe the FX market will return to a “back-to-basics” approach where vanilla and very low-complexity and transparent products will become more popular with clients and investors,. Do you agree with that?
Concerns about credit and counterparty risk mean more participants are looking at safe, regulated products and markets. This is affecting the way they approach FX trading, turning away from using FX to generate alpha and going back to risk-management strategies. As revealed by our recent survey, dedicated FX funds plummeted 30 percent to four percent for real money investors and 27 percent to 15 percent for active managers. Real money investors’ focus on hedging and overlay strategies rose 51 percent to 82 percent, while active investors’ 73 percent was 44 percent above last year’s figure. That said, we definitely believe that in order for complex FX products to grow the way they did up until 2008 will require the development of a robust clearing mechanism for OTC FX products. This will be critical for future growth in this product segment, and presents an opportunity for a company like CME Group to continue to serve the global FX market through innovation and customer service.
By offering both investment as well as risk-management opportunities, CME Group has traditionally attracted a wide variety of clients. What's likely to fuel the future growth of your FX business and where will you be looking to expand your global client base over the next few years?
One of the key drivers behind our diverse customer base is the range of asset classes we cover, from energy and metals to interest rates, equities, agricultural commodities and alternative investment products. And backing this up is the geographical diversity which we are focusing on strongly, particularly in the FX business: we’ve significantly increased our FX staff levels in London and Asia, and we are actively promoting our markets and products to global market participants. Where appropriate, we will support this with product launches, like that of the Turkish Lira futures in the first quarter; but FX is by its nature the most global of asset classes, and we see great potential for growth in the hours outside US trading times. Combine that with the breadth of our product offering, our OTC clearing capabilities, and our fast, accessible electronic trading facilities, and it’s clear that we’re just scratching the surface.