Three years ago, Kevin McPartland, Head of Market Structure & Technology Research at Greenwich Associates, predicted that while the OTC market would remain strong, regulatory-driven changes would “drive futures to become an important tool in foreign exchange traders’ toolbox and a much bigger part of the FX marketplace.”
Back in 2014, McPartland argued that clearing for NDFs would bring with it initial margin requirements that would fundamentally change the economics of the product and that a shift towards futures trading was inevitable, pointing out that FX futures listed at the exchanges were nothing less than IMM (quarterly) dated NDFs with a set of notional per contract. Today, he says, while there is no sign that NDF and options volumes are declining, with uncleared margin requirements and Basel III rules starting to take effect, clearing of those contracts is beginning to rise despite a lack of regulatory mandate.
So too did McPartland predict that exchanges would create more customisable contracts, to fulfil the need for costeffective hedging, such as monthly futures and products similar to those developed at Eris Exchange for interest rate swap futures. With monthly futures launched by CME Group in February and the first Rolling Spot Future, from Eurex, understood to be in the pipeline, this is now happening.
With record levels of participation, shown by the large number of open interest holders, CME Group made a significant expansion to its FX offering with the launch of FX monthly futures contracts, providing FX market participants with access to the front months of the FX forward curve with the capital and operational benefits of trading listed futures. This combines as much flexibility as possible, with the cost benefits of trading on-exchange.
FX monthly futures will be offered on six currency pairs where CME Group already offers quarterly futures: AUD, GBP, CAD, EUR, JPY and EUR/ GBP. For each currency pair an additional three monthly contracts will be listed at any given time resulting in four consecutive months of monthly expiries. The first serial listed was the April 2017 contract.
Paul Houston, Executive Director and Global Head of FX at CME Group says: “The launch of FX monthly futures is in response to feedback from global customers who want to trade FX futures for the capital efficiencies they bring but require increased granularity to meet their hedging needs – thus the move from quarterly to monthly expiry dates for the major currency pairs.”
He adds that demand is coming from different sectors looking to trade FX futures. Buy-side participants have said that because of constraints in the OTC market particularly with regard to credit and the uncleared margin rules taking effect, they would like to trade futures but would like greater granularity in terms of dates. Also, forward traders at banks are increasing looking to trade futures; these additional contracts offer an opportunity to trade both spreads and outrights. Furthermore, with prime brokers reviewing their business models, as the cost of providing access to credit and operational services such as a CCP in the OTC market goes up, Houston believes the futures market is now offering a viable alternative.
The CME exchange is focusing on driving growth by offering new ways of trading FX. Another example of this is the development of volatilityquoted options, which enable users to trade an option in terms of volatility, instead of price, with an “auto-hedge” into the corresponding underlying futures contract. This way, the delta-hedged transaction reduces execution risk allowing for deeper and more stable liquidity.
By quoting the standard CME expiration contracts in annualised implied volatility terms, market participants exchange a standard option in premium and a delta hedge in the standard underlying future. Six major currency pairs were listed in November, with separate liquidity pools from the premium-quoted options with unique contract identifiers, until Triangulation was launched, at the end of February 2017, initially on the on AUD/USD pair.
CME Group’s premiumquoted market is an actively traded one, about $10 billion daily, by a broad range of counterparties. While a lot of the non-bank market makers, and some of the banks, trade in the premium market, much of the OTC market trades in volatility terms, and most of the market, on the OTC side, is priced in volatility terms.
Houston adds: “There is a push to have more exchange-traded products, for a number of reasons including greater capital and cost efficiency. Given FX options are one of the FX products impacted the greatest, we thought it would be a good idea to launch volatilityquoted options to make it easier for OTC participants to trade on-exchange.”
The true innovation behind the launch is the link CME has made between its premium-quoted market into its volatility-quoted market, using triangulation, with listed futures making up the third point in the triangle. This means the VQO markets can benefit from existing liquidity in the PQO markets; one price can be implied into another, which will kick-start the marketplace and allow the two pools of liquidity to interact with each other. Once the marketplace has adapted to triangulation in the AUS/USD, it will be rolled out for the remaining currency pairs over the next few months.
Says Houston: “When a volatility-quoted option is traded, the implied volatility is more stable than the premiumquoted option, so this allows bigger sizes to be traded. By enabling participants to trade the volatility-quoted option and a future at the same time, which is the delta hedge, all three marketplaces interact with each other, all on the same nextgeneration matching engine.”
The introduction of triangulation at the exchange is a significant step as it goes further than simply creating exchange-traded products that mimic the OTC conventions by bringing the two markets together to create a new hybrid product. “We don’t want it to be a standalone product but for it to interact with our current marketplace as it gives the client base more flexibility to trade in volatility terms and in a more capital efficient manner. It is clear that the exchange-traded options are more capital efficient, there are a lot of netting benefits, and this offers counterparties another way to trade options, which is similar to the OTC market,” adds Houston.
Lee Bartholomew, Head of Derivatives Product R&D, Fixed Income and FX at Eurex, says that the exchange is very much focused on the FX market and following the acquisition of 360T last year has undertaken a full-scale review of the business, across both exchange-traded FX and OTC products. He says: “The listed and OTC FX clearing business, together with the 360T offering, gives Deutsche Börse a pretty compelling offering to serve the market. We are growing all three streams in parallel in order to leverage the synergies across the three and offer value to end-users.”
FX futures and options are fully integrated into Eurex Clearing Prisma, its portfolio-based margining tool. Eurex Clearing Prisma calculates combined risks across all derivatives markets cleared by Eurex Clearing and enables cross margining between products within individual asset classes.
Last September, the exchange extended its listed FX Futures and Options portfolio to include six new currency pairs, now covering 7 of the G10 currency pairs, while the overall minimum block trade sizes was reduced across all currency pairs to further improve hedging opportunities. He says: “Our FX product offering is beginning to build real traction now.
We appreciate that we have effectively re-launched some of the existing products but we feel that we have the right approach this time round and are ready to move this forward. We have listened to what our members have said they want and hopefully come back with products that match their needs.”
Bartholomew confirms that some new initiatives and products are in the pipeline for the first half of this year, one of which is the move to 23 hour trading of FX futures to bring the exchange in line with the rest of the market, when margining will be calculated in a near real-time basis, the other a wholly new FX product – an exchange-traded Rolling Spot Future, an industry first, that will closely mimic and mirror the OTC market. “Suffice to say, the listed piece is very important for the exchange, as part of the picture that Deutsche Börse is trying build up in terms of its FX product offering,” he adds.
Deutsche Börse has developed and is finalising a one-stopshop for foreign exchange with OTC FX, cleared FX and listed FX products available via the 360T GUI.
Bartholomew adds: “We see the listed and OTC piece joined up and part of a targeted approach which we expect to deliver this year. Further product development will come on the back of this. The plan is to build momentum and then from there bring new products on board in a timely fashion. We need to get to market with what is in the pipeline first, build liquidity and market share and then look to adding new products.”
NEW INITIATIVES AND DIVERSIFICATION
In Russia too, listed FX contracts saw growth, with the total trading volume of the Moscow Exchange (MOEX) FX Market reaching RUB 330 trillion in 2016, up 6% year on year. Marc Millington-Buck, Head of International FX Business at Moscow Exchange, says that the most important factors attracting greater interest in the exchange are access to the dominant, and highly liquid, ruble FX market and the reduction of counterparty and settlement risks. He says: “Credit risks are deemed to be still high for both local, and more importantly foreign players, so use of the CCP, part of the MOEX group, for all exchange-traded products at MOEX is certainly seen as beneficial, reflected in the continued growth of turnover from the exchange’s increasing client-base.”
Moscow Exchange continues enhancing and diversifying its portfolio of currency products. In 2016, it launched new deliverable futures contracts on USD/RUB, EUR/RUB and CNY/RUB and associated swap contracts, as well as a new currency pair, CHF/RUB. Turnover in the new instruments exceeded RUB 62 billion. Currency pairs launched in 2015 also thrived. Trading volume in British pound more than doubled to RUB 47 billion and in Hong Kong dollar by more than 20 times to RUB 60 billion.
Millington-Buck says the exchange is increasingly focusing on the development of clearing services aimed at reducing costs for market participants and improving risk management. In 2016 alone, the exchange offered interproduct spreads helping to decrease margin requirements for EUR/USD trades, a risk balancing service between the FX and Derivatives Markets, a function to consider interest risk associated with TOM instruments and a number of other projects. He says: “Collateral requirements will be reduced for opposite positions in EUR and USD thanks to an inter-product spread, allowing trading firms to reduce their funding costs. To unify collateral calculations, interest risk will be considered for TOM positions and margin requirements will be issued for overnight swaps similar to long-term swaps. In 2017, we will seek to further facilitate cost reduction for participants with the development of clearing services such as single collateral pool, unification of clearing processes and assets acceptable as collateral.”
A number of initiatives will be implemented in 2017 to keep the exchange attractive, such as the introduction of block trading and new market-making programmes and tariff enhancements. He adds that one of the most promising areas of further development at MOEX being planned is the provision of net settlement for RUB FX spot and forward products, from both on-exchange and OTC FX transactions, on basis of central clearing via the CCP. “This concept would help large players, which are active in both segments of FX market, to reduce settlement risks by bringing them into a single clearing process.”
ASIAN HUB FOR LISTED FX
According to KC Lam, Head of Rates and FX, at Singapore Exchange, the FX futures market has a deep symbiotic relationship with the OTC market that benefits the overall market in the long run and although futures are still small, relative to OTC, the listed FX futures market is growing the fastest. While the FX market globally has shrunk by more than 5 per cent in 2016, according to BIS’s triennial survey, Lam says, over the same period, SGX’s FX market has increased from $310 million to $229.6 billion – a significant amount by any measure. “This shows that despite an overall shrinking market, FX futures are a growth area for SGX. Such trends are encouraging as we focus on enhancing our role as a trading hub for listed Asian FX,” he adds.
SGX has witnessed stellar growth its Indian rupee (INR and offshore Renminbi (CNH) futures contracts. Since the launch of CNH futures in October 2014, average daily volume of SGX USD/CNH futures has increased by 253% from 2014 to 2016. Similarly, INR futures have been growing at a compound rate of 385 % from launch in November 2013 to January 2017.
Says Lam: “We are pleased to have strong support from market participants who use our venue to hedge their FX exposures. Many of them are already trading either equityindex futures or commodities futures and swaps on our platform – they are the most natural users of our FX contracts. We listened to customers who told us that it would benefit them if we were to also list FX options contracts, as options offer a more cost-effective and flexible method to hedge their portfolio exposure. As a result of their feedback, we added CNH and INR options to our complex in the last quarter of 2016.”
SGX is focused on enhancing price discovery in Asian FX derivatives, and has now introduced 15 listed futures and two listed options contracts. As well as listing Asian currencies against the USD, SGX also offers crosses, which are useful for hedgers to manage risk.
One of the features of SGX’s FX derivatives is that it lists a total of 13 serial months for most contracts. This innovative approach allows for finer hedging and Lam says it is one of the approaches the exchange is taking to adapt to the evolving needs of traders. The exchange is also working with market participants to offer margin offsets for their transactions through appropriate risk-based margining, thereby reducing the cost of trading and SGX is one of the first exchanges to offer cross margining between FX derivatives and equityindex derivatives products.
Continuing to innovate, SGX and EBS Market are collaborating to offer SGX block futures on the EBS trading platform. Pilot trades have been executed and the launch is imminent. Lam says: “The collaboration offers our customers the choice of trading spot, Non-Deliverable Forwards or listed FX futures – all on one platform. It has also made it possible to offer other listed asset classes such as commodities and equity-index futures on the same platform.”
SGX was also one of the first exchanges to begin clearing for FX. SGX clears Asian NonDeliverable Forwards in seven currencies against the USD, namely CNY, INR, KRW, TWD, IDR, MYR and PHP, and has cleared US$6.4 billion to date. Lam says the exchange expects growth in OTC NDF clearing to increase over time, as market participants find ways to comply with mandatory margining and capital requirements that have become more stringent, while exchange-traded FX products can provide a platform for parties seeking enhanced price transparency for their standardised transactions.
“Our depth in INR/USD FX futures over the past two years is an indication that market participants have become more receptive to exchangetraded products. We are actively consulting with the industry on new derivatives to consider, and we hope to roll out more contracts in the coming year,” Lam says.
RMB LIQUIDITY AGGREGATOR
The Hong Kong Exchange (HKEX) is also seeing an uptick in exchange-traded FX that is being driven by the internationalisation of the renminbi. Julien Martin, Managing Director and Head of Fixed Income and Currency Product Development, HKEX, says that a key driver of interest in HKEX’s RMB currency futures is the increased market awareness of the merits, or even necessity, of hedging RMB exchange rates. “Investors, both individuals and institutions, have started to realise how the RMB FX volatility can have an impact on their operations in terms of RMB assets, liabilities and cash flow. The RMB’s two-way movement has become accepted as a metric in investors’ risk management framework,” Martin says.
A case in point was the first week of January 2017, when there was heightened RMB movement against USD. During the period, HKEX’s USD/CNH Futures set a single-day trading record of 20,338 contracts (US$2bn notional), and an open interest (OI) record of 46,711 contracts (US$4.7bn notional) - OI at HKEX accounts for about two-thirds of the open interest for all the world’s exchange-traded USD/CNH futures. Over the past years, HKEX’s USD/CNH futures have been the world leaders in liquidity and distribution among exchanges, as corporates, asset management firms and fund houses, proprietary trading firms, brokerage firms and professional investors all seek to use RMB futures.
But while SGX’s Lam believes the inter-related listed and OTC market will continue to benefit each other, Martin says HKEX is seeing signs of some OTC turnover moving to on-exchange, due partly to FX becoming a new asset class for existing futures trading but mainly due to the changing regulatory and capital requirements for uncleared OTC contracts.
From 1 March 2017, all firms with uncleared OTC portfolios must exchange variation margin daily, which is quite new for many users of OTC products. The requirement to exchange initial margin is being made mandatory in stages over time until September 2020. Martin says: “This is illustrated by our diversified volume contributions from over 100 exchange participants, with strong volume uptick from both banking entities and brokerage houses. The regulatory and capital benefits of trading listed products have become more pronounced. HKEX offers orderly, equal and transparent trading in a single marketplace. This is attractive to all participants so we expect our distribution to continue to grow.”
Central to HKFE’s value proposition is that it is a liquidity aggregator on RMB FX futures and options, as it offers continuous and tight bid/ ask liquidity. On cross-currency hedging, HKEX offers direct trading of EUR-CNH, AUDCNH and JPY-CNH besides the standard USD pairs. This provides a venue for investors to directly trade the crosses and diversify their FX strategy. While the initial volume has been moderate, all these CNH crosses have designated market makers who can provide both continuous quotes and quoteson-request for investors.
Furthermore, the imminent launch of USD/CNH options will directly complement the exchange’s existing USD/ CNH futures, and will allow investors to deploy trading and hedging strategies for various market conditions with minimal counterparty risk. They will provide investors a hedging tool against RMB volatility amid the ongoing RMB liberalisation process and policy development towards a market-driven framework In addition, along with RMB two-way movement, the size of the OTC RMB options market has grown over the years - average daily volume was US$18bn in 2016, according to the Bank of International Settlement. Also, the majority of volatility risks are in the form of OTC vanilla options, with a substantial amount (about USD100bn+) of USD calls/call spreads placed on the market since August 2015. “This further strengthens our business case of bringing this vanilla form of RMB options on exchange,” adds Martin.
Uniquely, cross currency swaps are cleared in HKEX’s OTC Clear via the Hong Kong Inter-bank Real Time Gross Settlement (RTGS) system. Clearing members of OTC Clear are required to be either a member of the RTGS system or hold settlement accounts with a member of the RTGS system. Products currently handled by OTC Clear include several FX NDFS (USD/CNY, USD/INR, USD/KRW and USD/TWD) and currency basis swaps (USD and EUR) with different residual terms. Says Martin: “We expect to see more synergies for clients arising from the OTC Clear and exchange-traded products, in terms of capital savings and product /operational synergies.”
According to McPartland’s report in 2014, a conservative 5 per cent move out of OTC FX derivatives into futures would cause FX futures volume to grow by over 50 per cent —a huge boon for futures exchanges, and one they are still determined to attain.