The other trend is that listed FX and OTC trading are increasingly housed under the same roof. For example, within Europe there have been mergers and acquisitions such as CME Group’s purchase of EBS via the acquisition of NEX Group, LSEG’s purchase of Refinitiv FXAll; Euronext’s acquisition of FastMatch and Deutsche Boerse’s acquisition of 360T. And many of the leading exchanges have put the need for a hybrid trading model at the forefront of their product development, typified by the Exchange for Physicals service developed by Eurex Clearing.
Building critical mass
Over the previous few years, Eurex Clearing, the derivatives arm of Deutsche Boerse, had developed a listed FX capability. The last time e-Forex magazine spoke to Lee Bartholomew, global head of fixed income & currencies derivatives product design at Eurex, the focus for the firm was on achieving critical mass for its listed FX offering.
“The focus is still on building critical mass,” says Bartholomew. “We are making good progress on that front. A number of banks like Goldman Sachs and UniCredit have gone live and we have three more global banks in the pipeline, ready to go live before the end of the year. Alongside 360T, we feel we have a very clean and compelling offering and we are all set for accelerated growth in 2024.”
Increasingly, buy-side firms are telling their sell-side counterparts to set up with Eurex Clearing, says Bartholomew. “There is a growing realisation within the fixed income market that listed and OTC trading can be complementary. That has led to a degree of comfort among both bank and non-bank liquidity providers with listed FX and that suits Eurex. We have spent the last several years doing the heavy lifting and building out the platform. Now our focus is on activation and implementing portfolio listing and other activities.”
There is also a realisation among sell-side banks that listed FX trading is not an adversary to the OTC world. “It is not about competing with the banks. Increasingly, banks are looking to segment their trading into high touch and low touch. By using on-exchange trading for those assets and instruments with low margins and high volumes, it allows those banks to focus on the high-value, high-touch and high-return instruments and assets,” he says.
“By using on-exchange trading for those assets and instruments with low margins and high volumes, it allows those banks to focus on the high-value, high-touch and high-return instruments and assets,”
Lee Bartholomew
The reasons for the greater comfort with on-exchange trading are three-fold, says Bartholomew. The sell-side has figured out how to embed and optimise technology within their setup to accommodate structured themes and products. “All the verticals are integrated,” says Bartholomew. “Electronic trading is more prevalent in listed markets and that makes it easier to integrate workflows. And there is more comfort with the plug and play model which allows sell-side banks to automate more of their operations and to focus more on high-touch trades.”
Another trend is that ETFs have become more prevalent and they are becoming multi-currency which creates a rebalancing risk. “The ecosystem of listed products is evolving and people are working out how to monetise aspects of that market,” says Bartholomew. “We try to work collectively and collaboratively with market participants to deal with evolving trends. We are trying to grow the number of apps that we have on the platform and to focus on areas where we can provide a point of difference.”
Over the previous two years, Eurex has sought to develop cross-border agreements with other exchanges to expand its international footprint, notably the Korea Exchange and an agreement struck in 2021 to list KOSPI and USD/KRW derivations at Eurex, thereby expanding its presence in the Asia market and also adding more liquidity and extending trading hours.
“We have always been open to strategic alliances,” says Bartholomew. “We want to be the incumbent destination for euro crosses, for the Scandi currencies and for other instruments or currencies where we have a strong presence. We have an expanding client base in Asia but we are not looking to compete directly with Singapore Exchange (SGX). There is no point trying to break into new markets if we don’t possess a distinct advantage.”
Bartholomew says he has spent some time on making the Eurex message clearer when it comes to listed FX. “It is still a very nascent business and you cannot be all things to all people. It is about simplifying our overall strategy. We feel there are two markets where we want to be global and where we feel we can create the best value for the end customer – credit and FX.
“Basis trading is something people want to do – we see that in portfolio trading – ETFs in the US and FX and OTC and the listed worlds and regularly trade basis. If you are able to create products that are flexible, you can then look at what service enhancements you can add,” says Bartholomew. “Regulations continue to foster more efficiency in the FX market. But you also have to plug into traders’ decision-making and factor that into product development.”
Growing buy-side adoption
As of July 2023, the CME Group FX futures and options market trades an average notional daily volume of US$81.8 billion, as opposed to $76 billion in 2021. According to CME Group this increase is down to growing buy-side adoption of cleared FX products. It is also an indication that more investors are using exchange-traded derivatives as an alternative to OTC products to optimise funding and the capital impacts of Basel II’s implementation of SA-CCR and Uncleared Margin Rules (UMR). YTD 2023, CME Group has cleared 98.5% of the global volumes in EUR/USD FX futures according to FIA data; the remaining 1.5% was shared across another 5-10 venues that also offer the contract.
However, there is also a common misconception, states CME Group , as regards liquidity and the belief that FX futures are not liquid enough to trade on exchange and are better traded OTC. “While there is clearly a role for both futures and OTC venues in liquidity provision, it is useful to place the CME FX futures market within the context of the leading OTC FX venues, using traded volume as a proxy for liquidity,” they say.
“An increasing number of new participants, particularly from the hedge fund and asset manager community, are looking to access futures liquidity to solve margin and capital challenges.”
Paul Houston
The exchange cites a working paper published by the Bank of International Settlements (BIS) earlier this year which found that “a growing number of market participants of all types now seem to consider currency futures traded on the CME as at least a close cousin of the primary [spot FX] central limit order book (CLOB) venues”. Furthermore, CME Group states that the robust liquidity and use of its CLOB as a complement to the Block & EFRP activity is vital for a good client experience and trading efficiencies. The firm, robust liquidity in the CLOB is available on a truly all-to-all credit agnostic basis which combines with a huge ecosystem of over 90,000 traders to provide benefits such as zero reject rates and the ability to trade passively. In 2022, almost two-thirds (63.1%) of hedge fund and asset manager volume was traded passively in CME FX futures and 70.4% of volume was traded passively in CME FX options. Group Liquidity is more than just volume though, says CME Group, citing reject rates, market impact, the ability to trade passively and the diversity of the trading ecosystem as “hugely important” factors for traders. Furthermore, CME Group states that its use of CLOBs means that there is diversity of users, zero reject rates and the ability to trade passively. In 2022, almost two-thirds (63.1%) of hedge fund and asset manager volume was traded passively in FX futures and 70.4% of volume was traded passively in FX options.
According to Paul Houston, global head of FX products at CME Group, many of its customers have long recognised the liquidity benefits of CME FX futures as a complement to OTC activity. The difference in 2023 is that there is now the same recognition from the buy-side. “An increasing number of new participants, particularly from the hedge fund and asset manager community, are looking to access futures liquidity to solve margin and capital challenges,” said Houston.
The growth of Bitcoin futures
US-based exchange operator Cboe Global Markets is set to introduce trading in margin futures on bitcoin (BTC) and ether (ETH) in January 2024. The trading and clearing will be handled by Cboe Digital, the exchange group’s virtual assets subsidiary which was given permission by the Commodity Futures Trading Commission in June to offer margined crypto futures.Margined trading allows investors to post a percentage of their total position before trading, as opposed to fully collateralised futures contracts. According to the exchange, it is the first time a digitally-native exchange in the US has offered such a product.
Cboe also claims to have the support of several trading firms, both traditional and crypto-focused, such as StoneX Financial, Cumberland DRW, Jump Trading Group, Marex and Wedbush. Cboe Digital president John Palmer described the development as a “significant milestone” for the company. “We believe derivatives will foster additional liquidity and hedging opportunities in crypto and represent the next critical step in this market’s continued growth,” he said.
The move has also been welcomed by a number of trading firms. Chris Zuehlke, global head of Cumberland DRW, said that “providing secure access to regulated futures markets is key to maturing this nascent asset class and enabling broader institutional participation”. Thomas Texier, head of clearing at Marex said “there is customer demand for these products” and “Cboe Digital’s margin futures launch will help bring competitive technology and innovative solutions to regulated markets”.
And while this may be true, the majority of institutional interest in the US remains focused on the prospect of a crypto spot ETF being approved by the Securities and Exchanges Commission (SEC).
BlackRock is the latest asset manager to file with the SEC for such an ETF and in its application the asset manager highlighted a perceived contradiction between the regulatory treatment of crypto futures and crypto spot ETFs.
“Given that the Commission has approved ETFs that offer exposure to ETH futures, which themselves are priced based on the underlying spot ETH market, [BlackRock] believes that the Commission must also approve ETFs that offer exposure to spot ETH,” states the BlackRock application.
Volatile market conditions
Alongside the evolving regulatory regimes as a result of UMR and SA-CCR which has led to investors’ increased use of listed FX futures to help reduce capital costs, another headwind for listed FX has been the volatile market conditions, says KC Lam, global head of FX rates at SGX Group. “The past year has seen one of the most volatile global interest rate rises and inflation in recent history,” he says.
“The increased volatility of Asian currencies due to divergent monetary policies across central banks, alongside geopolitical and economic uncertainties, have led to heightened risk management and hedging activities across our key SGX FX futures contracts. Notably, activity and liquidity from US and European market participants has been on the rise, with over 40% of SGX FX futures traded in US and European trading hours.”
SGX has looked to build on this increased demand by launching two new market data offerings – the SGX Trade-Weighted CNY Index that tracks the performance of a basket of five major trading partners of China, and the SGX Trade-Weighted INR Index that tracks the performance of a basket of five major trading partners of India.
“The increased volatility of Asian currencies due to divergent monetary policies across central banks, alongside geopolitical and economic uncertainties, have led to heightened risk management and hedging activities across our key SGX FX futures contracts.”
KC Lam
The exchange has also looking to improve its trading platform Titan to support the increase in products, participants and volumes, including extended trading hours, enhanced risk controls and system safeguards to help market participants manage their trading and clearing positions round the clock.
And more recently it has focused on market structure improvements for FX derivatives. These include enabling bait orders in our trade registration system for SGX USD/CNH Futures to improve price discovery and advertise the liquidity available in the marketplace. “This has resulted in tighter top-of-book quotes especially for longer tenure contracts. This will also help create implied out orders based on an outright together with a spread order, which will increase liquidity across the curve,” says Lam.
“To cater to firms that utilise different Trading Codes or brokers to route their orders, we enhanced our Self-Trade Prevention (STP) feature to include a higher level of STP at the Trading Group level (STP-TG); preventing orders from participants that belong to the same STP-TG from matching,” says Lam. “To address feedback from OTC participants wanting to engage in cross-product strategies, we launched USD/INR month-end contracts, making us the only international exchange to offer conventional USD base currency quotes.”
“To make it easier for participants to transact in large sizes without impacting the price of the underlying, we implemented the Titan OTC RFQ to facilitate block trades, allowing larger trades to execute more quickly and efficiently. And to enable clients to trade at-reference to an IOSCO benchmark and participants to enter and exit positions based on a single price point with a deep pool of liquidity, we have embarked on delivering the ability to trade at a reference rate,” says Lam.
“To enable clients who would like to replicate OTC FX forward positions but using the listed cleared futures format, SGX has introduced FlexC FX futures allowing participants to effectively mitigate counterparty credit risk with the flexibility of retaining bilateral trading relationships. This brings about lower margin costs and capital requirements and at same time enhancing capital and operational efficiencies,” says Lam.
Lam also referenced the steps taken to widen the exchange’s international footprint, attract new clients and grow their FX products and services. “As regulatory developments such as Basel III SA-CCR and UMR Phase 6 came into full force, we drove industry discussions locally and globally to educate clients on navigating changing regulations,” says Lam. “We also publish comprehensive educational material on UMR and SA-CCR on our website, including steps on how clients can utilise our derivatives to increase capital efficiency.”
Lam also says that the exchange continues its ambition to bridge the FX OTC and futures worlds. “We are the only FX futures exchange in Asia with an OTC FX trading venue and full OTC FX workflow automation. We also launched SGX CurrencyNode, an FX electronic communication network that connects global participants anonymously to unique and deep OTC FX liquidity pools.”
