Paddy, how complex a job has it been to develop your new FX Options clearing service, and in what ways has LCH’s collaboration with CLS helped to deliver it?
Developing the FX Options clearing service has been a pretty complex endeavour, with a number of elements that were new to the clearing house. The most significant change is that we are providing a new settlement methodology in partnership with CLS. This was the hardest part for us to develop, and we are delighted with the result and the market’s adoption of it.
The new service introduces several solutions that are new to OTC FX clearing, including the creation of a low-latency framework. Please tell us a little about those.
In the bilateral market, when one party exercises an option on another the notification is almost instantaneous via a messaging platform. We were aware that the FX Options market was focused on maintaining this level of latency when moving the trades to clearing and wanted to preserve the ability to manually decide whether to exercise the options. This presented a meaningful challenge, as in traditional clearing models many minutes pass between manually exercised option notices being submitted and allocations being received by user traders. Through a new low-latency pathway we managed to solve this problem for the market. Traders also told us that they valued the ability to trade any maturity date and any strike they like rather than being pegged to limited dates and strikes, so we provided this too.
How much capacity does the new service have and what direct benefits will it bring?
We have tested the capacity of the system up to well beyond what we expect to see in the early stages of adoption and are confident the system could clear the current interbank FX Options market in our chosen currencies. Clearing FX Options brings the usual clearing benefits of reduced counterparty risk and hence lower margin and capital requirements, in addition to lower operational costs and risk. Options clearing will bring the ability to much more easily compress and net down options risk too.
Why is the launch of this product such a significant step for both LCH and the whole FX market?
Clearing FX Options is a very material step forward, as it provides the market with a safe, robust clearing service for the most complex high-volume FX market product. In addition to being a material market in itself, this could open up the way to clearing other FX products.
Who is the service initially being made available for?
Initially the service is available to all members of ForexClear, a large group of financial institutions based in the UK, US, France, Germany, Spain, Holland and Hong Kong, which include all the largest FX banks. We are open to new members who wish to join too, subject to them meeting LCH’s standards, including our membership criteria.
In what ways could it unlock significant new opportunities for market participants?
Our service offers members the ability to clear spot, forwards and FX swaps, which are hedges for their cleared FX Options portfolios. It could potentially extend the service to offer clearing of other FX products, for instance, more forwards and FX swaps, which are not related to FX Options if we deemed it appropriate following internal review and subject to regulatory approval. These are much the biggest FX products by volume and represent the largest financial market in the world.
What currency pairs are currently covered by the service and what plans do you have to add further FX products in the future?
To begin we are covering EURUSD, USDJPY, GBPUSD, USDCHF, AUDUSD, EURGBP, EURJPY and EURCHF, eight of the highest-volume currency pairs in the FX Options market. We are also looking at clearing non deliverable FX Options, and adding other currency pairs. All new product releases are subject to regulatory approval.
How has the market responded to the launch so far, and what are your expectations going forward for its increasing adoption?
We have seen a near universal positive reaction to the offering to date. We are expecting to see material volumes in the service very shortly, and that volumes will grow quickly as we are working with most of our members to assist them with taking up the new service.
In what ways could your successful partnership with CLS open the door to future collaborative efforts focused around other products and services within deliverable FX?
We plan to look at leveraging our valuable partnership with CLS to look at the possibility of clearing other FX products.
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