Exchanges align for new FX business

While volumes continue to grow, the world’s derivatives exchanges are busy tweaking their FX contracts and launching new instruments in the light of the current regulatory debate over mandatory requirements for clearing bilaterally traded OTC contracts, as well as the general push to get as many of the standard OTC contracts traded on exchanges as possible.

First Published: e-Forex Magazine 44 / FX on Exchanges / July, 2011

New contracts from ICE

New contracts from ICE

The IntercontinentalExchange (ICE) has launched ten currency pairs to add to the larger sized contracts in its existing portfolio. The larger contracts are more akin to exchange-traded contracts and will sit alongside the smaller contracts (€100,000).

ICE purchased the New York Board of Trade, and a thriving FX business, almost five years ago and the selling point at the time was that the FX products were all priced exactly to the way they are priced in the cash and EFP business. However, competing exchange Chicago Mercantile Exchange (CME) has built substantial volumes in screen traded activity by offering larger sized contracts (€125,000) as well as the €100,000/£62,500 contracts.

Ray McKenzie, vice president of ICE Futures U.S., says: “The dollar index has been very successful for us and we have seen such substantial growth – nearly 40,000 contracts a day last month, compared to 6,000 a day in May 2010 – that many of our customers trading the index have said if we matched CME’s sized contracts in the euro and sterling, we would get a lot more business from them on the ICE platform because they like the speed of the platform and the lower fees. They also like the fact they would be able to cross margin currencies against the dollar index.”

Ray McKenzie
“The main message is that we are very dedicated to the FX market, and are building our FX products on the back of the success of the dollar index contract.”

Ray McKenzie

“The main message is that we are very dedicated to the FX market, and are building our FX products on the back of the success of the dollar index contract.”

Regulatory uncertainty

McKenzie believes that the continued uncertainty over OTC regulation, and what products will and will not be cleared, is driving more market participants to exchanges. He adds that ICE intends to offer the best of both worlds and notes that  ICE already clears many OTC products, in other commodities.

He says: “We intend to offer a choice to our customers, whether they want to trade and clear OTC products through us, this is what we have been doing for years, or if they want to trade a futures contract on a listed exchange. The main message is that we are very dedicated to the FX market, and are building our FX products on the back of the success of the dollar index contract.”

He adds the that OTC market has evolved with more than 100 platforms to trade spot, but ICE believes that FX futures have always been a proxy for spot, and with low interest rates and good liquidity, McKenzie says many are moving towards the more transparent futures market. “The futures exchanges have extremely good technology which is a very compelling selling point and the buy-side customers are starting to look at cleared exchanges as part of their business. I think the market will continue to evolve and you will see more and more FX business traded on exchanges. This does not mean that OTC trading will go away, it is just that FX will grow to a much more significant percentage of overall exchange volume.” 

New options from ISE

In January this year, the first wholly electronic options exchange, the International Securities Exchange (ISE), increased its options portfolio with the launch of currency options on the Brazilian real. ISE currently lists FX options on ten currency pairs. The USD-based, or “per US$,” currency convention is available for all ten pairs and allows investors to express their views on the strength or weakness of the US dollar relative to global currencies while adopting the trading strategies they currently use for equity and index options. In a further boost for the options’ business, ISE then received regulatory approval for early opening (7.30am ET) and extended the FX options trading hours.

Kris Monaco
“By opening the market two hours earlier, we are meeting demand of a broader range of foreign exchange traders, especially from the UK and other countries in Western Europe.”

Kris Monaco

“By opening the market two hours earlier, we are meeting demand of a broader range of foreign exchange traders, especially from the UK and other countries in Western Europe.”

Kris Monaco, head of new product development, at ISE says: “By opening the market two hours earlier, we are meeting demand of a broader range of foreign exchange traders, especially from the UK and other countries in Western Europe. We have seen ISE’s FX options products benefit from additional liquidity during peak FX trading hours, although volume in the products has been flat over the last several months.”

Optimise

In April, the ISE began rolling out its new options trading system on Deutsche Börse Group’s Optimise™ trading architecture. With Optimise, ISE will significantly improve the latency profile of its trading system and offer enhanced functionality to member firms. The Optimise launch began with ten symbols that trade in ISE’s Second Market. The migration of symbols in ISE’s primary market began in May, with the full roll out expected to conclude by the end of July.  Initially, Optimise is being rolled out to replace ISE’s options trading system in the US only. The cutting edge technology has the capability to ultimately connect the global network of exchanges, operated by ISE’s parent company.

More competitive FX market on JSE

The Johannesburg Stock Exchange (JSE) is making its currency derivatives market more attractive and competitive by providing incentives for larger currency deals and greater trading flexibility for investors. The measures include changes to the fee structure and the launch of new trading strategies.

More competitive FX market on JSE

The local currency market was first established in 2007, but institutional investors and corporates only entered the market in 2008 after a special dispensation in that year’s budget address. Since then 20 million contracts worth R175 billion have been traded. Dollar/Rand contracts make up more than 80 per cent of the trading activity on the exchange. 

Warren Geers, general manager for Derivatives Trading at the JSE, says: “We believe that there is still huge potential for growth in our market, especially now given the considerable discussion regarding derivatives reform and proposals to move more trade on exchange. Investors want flexibility and risk management; we believe that we can offer them both.”

New fee structures

Because competitive pricing plays a key role in attracting participants, the JSE is set to introduce new sliding scale fee structures as an incentive to trade greater volume at the exchange and to encourage same day trading activity, the JSE has committed to a zero fee for the second leg of all intraday trades. “We would like to see more day traders participating in our market. At present this type of investor is not very active in our market,” says Geers. 

To promote cross currency trading, the JSE will now only charge on one side of the transaction. This allows participants to synthetically trade any two foreign currencies against each other and the fee will be as if the participant was trading the direct cross-currency. 

An advantage of trading JSE-listed derivatives, as compared with over-the-counter (OTC) alternatives, is that on-market instruments require no foreign exchange clearance and are settled in rand. JSE’s derivatives also offer the reassurance of Reserve Bank and Financial Services Board regulation along with South Africa’s five major banks as counterparties. 

Flexible contracts

The JSE has launched a new initiative on the foreign currency contracts. Any Day Expiry contracts allow investors the flexibility to pick the expiry date of the contract. The introduction of this new currency product is in response to the wholesale market looking to hedge their currency risk with increased precision. “This new contract meets the needs of a certain clients, for example, hedge fund managers working on a short term currency strategy or those in the import and export arena who would like to match exact expiry dates with those of the delivery of goods,” says Geers.

Warren Geers
“Products like the Any Day Expiry currency derivative demonstrate that the JSE is cognisant of the investor’s needs for both flexibility and sound risk management,”

Warren Geers

“Products like the Any Day Expiry currency derivative demonstrate that the JSE is cognisant of the investor’s needs for both flexibility and sound risk management,”

Apart from the added flexibility of picking the expiry date, all other contract specifications and fees remain the same as the existing currency derivative products, which expire on set quarterly close-out dates. 

“Many investors prefer using OTC derivatives because traditionally they are more flexible than their listed counterparts, but the reality is that they have a number of disadvantages, including counterparty risk and opaque pricing. Products like the Any Day Expiry currency derivative demonstrate that the JSE is cognisant of the investor’s needs for both flexibility and sound risk management,” adds Geers

Demand for customised products

In line with international trends, the JSE is seeing a greater demand for customised derivatives products that are traded on-exchange and with the introduction of more flexible contracts being listed and the exchange is experiencing even more demand from the asset managers and hedge funds as this suits them more than standardised contacts.

Says Geers: “We have seen the demand increase from users of OTC products trading more regulated exchange styled products. This has been driven due to mandates from funds and of course better price discovery.”

He adds that the launch was prompted by the need for more flexibility from exchanges, as opposed to only allowing for the normal standardised products. “Clients were also required to trade/hedge to specific dates and unless we were able to accommodate them, they would have continued to merely trade OTC styled products,” he adds.

As a result the exchange experienced its biggest month of trading in March 2011 since inception, and Geers says it was purely attributable to the new styled contracts being launched.

OSE gets set for FX growth

Matthias Rietig talks to Frances Maguire about how the exchange’s FX market is poised for growth when Japan’s new leveraging limits take full effect.

Osaka Securities Exchange’s (OSE) OSE-FX market offers eight yen currency pairs and three non-yen products. At present, the OSE has four designated Market Makers: Money Partners, JP Morgan, Citi and Ueda Harlow. In addition, 14 online brokers connect to the OSE-FX market. 

Matthias Rietig, advisor to the board of OSE, says that depending on demand the exchange may consider adding more exotic currencies in the future but at the moment the bulk of the trading activity is concentrated in Euro/yen, US dollar/yen and euro/US dollar contracts. Currently the user base of OSE-FX is completely made up of retail flow, most of them short to mid-term speculators, but Rietig says: “The market structure of OSE-FX also appeals to the very active crowd of Nikkei mini futures traders and we also start to see this layer engaging in our FX market.”

Matthias Rietag
“The market structure of OSE-FX also appeals to the very active crowd of Nikkei mini futures traders and we also start to see this layer engaging in our FX market.”

Matthias Rietag

“The market structure of OSE-FX also appeals to the very active crowd of Nikkei mini futures traders and we also start to see this layer engaging in our FX market.”

Order book market

The exchange provides an order book market, which Rietig says attracts the non-traditional FX players. He believes the market is set for growth due to the changes in regulation regarding the levels of leverage allowed in OTC products. Japan has seen explosive growth in the numbers of retail customers trading foreign exchange on margin through OTC online-brokers however the Japan Financial Services Agency (JFSA) reduced leverage limits for OTC-FX contracts to 50 times in August 2010. This will be further reduced to 25 times from August 2011. In addition there is a difference in taxation between listed and non listed FX products.

Rietig expects the exchange to win business because of the greater transparency offered by exchange-traded contracts. He says: “In order to promote transparency and offer a fair market the regulators are saying they want this business to move on to the exchange, and a regulated, market, OSE is the first of its kind that actually offers market depth.”

He adds that there is also a difference in the taxation because OSE contracts are technically derivatives – futures contracts with a CCP – and are more tax efficient at 20 per cent taxation as opposed to up to 50 per cent for OTC-FX contracts in Japan. He says: “We will most likely trade a lot more from August because then we will see the effects of the harmonisation e.g. the equalisation in leverage between OTC FX and exchange-traded FX. In addition the tax advantage and transparent order book should push more volume on exchange. 

“The platform we have is relatively strong, fast and stable, with latency at around one millisecond, this is also of interest to the agency brokers. FX is gaining more popularity among HFT firms globally, due to our very active Nikkei Futures and Options market a lot of these players are inquiring about the possibility to participate in our FX market as well. We haven’t rolled out next step yet, since we first want to grow the market a bit further but it will certainly come soon and then the whole FX market in Japan will change dramatically because we will have the tools to provide even more competitive tighter spreads to be a viable alternative to the OTC brokers and our competitor Tokyo Financial Exchange (TFX).”

Once OSE makes the step to connect agency brokers, if there is demand the exchange will also offer co-location, proximity and direct connection services – already offered with the OSE matching engine and used by retail brokers trading OSE on the new J-Gate platform that went live February 14th this year. The OSE-FX market provides FIX connectivity and is hence easy to access offering a global standard connectivity protocol.