The foreign exchange market has, since its inception, been an over-the-counter (OTC) market. However, since the financial crisis of 2008, market trading on exchanges has continued its evolution and growth across the globe. Volume continues to surge in the FX market – the latest triennial survey published by the Bank for International Settlements shows that $6.6 trillion of volume traded each day in 2019, up from $5 trillion in 2016.
The general rise in average daily volumes has helped growth in the futures and listed options world, too. All exchanges have seen a surge as a combination of new regulatory requirements and trading efficiency has attracted more buyers and sellers to centralized exchanges.
The most impactful of these regulations includes the introduction of margin rules for non-cleared swaps, known as UMR. Phased in since 2016, the last iteration was set to come into force during 2020 but was delayed by the Covid-19 pandemic. The bulk of market participants will now start to come under scope of the rules in September this year and 2022.
By 2022, around 1000 firms will be required to post initial and variation margin on swaps that are not centrally cleared at a central counterparty (CCP). In FX, this will include options, non-deliverable forwards (NDFs) and physically settled forwards.
Other regulatory incentives include the introduction of the standardised approach for measuring counterparty credit risk (SA-CCR), the Basel Committee on Banking Supervision’s new model for the calculation of capital needed to be held to cover the risk of default by counterparties in derivatives trades. This will be implemented in June of 2021 in the EU and on January 1, 2022 in the US. The danger for OTC FX is that the new rules could result in a significant cost increase for bilateral FX trades. Therefore, SA-CCR could still prove a further catalyst to on-exchange FX as cost savings are then factored in.
Other factors have helped drive the growth of FX trading on exchange. Volatility has been on the rise in the past 12 months, with a noticeable uptick during the financial crisis in the wake of the Covid-19 pandemic in March last year. The JP Morgan FX volatility index recorded its highest level (10.95) since the end of 2016 (11.26) and has remained elevated compared to recent years. This often helps to drive trading, such as hedging activity, to mitigate wider moves in currency pairs.
Net euro futures positons listed at the CME Group and reported to the US Commodity Futures Trading Commission for its Commitments of Traders Report show the highest net position ever at the end of September last year, and has remained significantly higher than in all previous years since the reports began. Latest figures from the CME show listed FX volumes were up from 775,000 contracts in January to 803,000 contracts in February. This surge in demand for exchange-based currency products from the world’s leading derivatives marketplace has been reflected across all global exchanges, which we will now focus on.
Against the Covid-19 backdrop of heightened market volatility and supply chain disruptions, resulting in greater demand for risk management, the Singapore Exchange (SGX) achieved new monthly records in 2020 across FX and a number of its commodity products. The exchange saw a flight to quality, at least for exchange-traded FX. When liquidity went missing and prices were gapping, SGX saw more volume going to its exchange because it has liquidity on a continuous basis all the way to closing of US hours. Clients said that SGX had demonstrated deeper liquidity in Asian currencies compared to the OTC market.
“As a result, 2020 was a record year for SGX FX futures, which posted a record high of US$1.43 trillion, up 8.6% from US$1.31 trillion in 2019 (year-end aggregate open interest at US$10.08 billion, up 27.8% y-o-y), as Covid-19 remained the top driver of economic and market activity in 2020,” says KC Lam, head of FX and rates at SGX.
That volume surge has continued this year. In February the exchange reported FX futures trading volume had jumped 7% to 2.3 million contracts versus January. This was particularly prevalent in INR/USD futures which was up 22% for the month thanks to high volatility. It also had its highest single day of volume recorded on February 26, with a total of 160,359 lots changing hands (notional value of US$4.39 billion).
As at the end of February, SGX FX Futures open interest was up 33% to 171,373 contracts with a notional value of US$11.2 billion. In USD/CNH futures, SGX’s volume market share rose 1.1 percentage point to 85% compared to January. USD/CNH Futures averaged US$4 billion daily as trading subdued during Chinese New Year, but month-end open interest hit US$8.87 billion, up 41% y-o-y.
Elsewhere, KRW/USD futures saw 35,066 contracts traded, which was up 46.4% from a month ago. This translates to a notional value of US$865 million, an increase of 26% m-o-m and 14% from the year ago period. Month-end open interest was at 1,880 contracts, or US$45.1 million. The increased volatility and resulting flight to quality have led to an increase in market share for two of the exchange’s key products. Currently, SGX has the largest global market share in INR/USD Futures (at 73%), and its market share in offshore Renminbi futures is approximately 85%.
“Regulatory pressures since the 2008 financial crisis have pushed the derivatives markets (including FX futures and OTC products) towards central clearing houses,” says Lam. “With global regulatory initiatives such as Basel III and MIFID II coming into play, financial institutions are facing an increasing burden of capital requirements. As phases 5 and 6 of UMR come into force, there will be a clear economic driver for more firms to embrace clearing of FX – in particular for NDFs and FX options,” he adds. Another of the key drivers for institutions to clear FX is having an effective solution to maximise capital and operational efficiencies, reduce costs and counterparty credit risk, while retaining bilateral trading relationships.
SGX sees FX as a promising growth pillar. As Asia’s largest and fastest-growing FX exchange, since 2013 the exchange now has 23 FX futures and two options contracts. SGX continues to support the FX ecosystem and clients in achieving greater capital efficiencies and greater ease in managing their portfolios, by growing, enhancing and diversifying its FX offerings including its suite of full-size and mini FX futures contracts, FX options and FlexC contracts. The exchange has been working closely with its partners to enhance connectivity and improve and automate workflows, including straight-through processing. Growing trends in the market has also presented SGX with opportunities to serve the market with innovative and differentiated products.
“The future of FX lies in the ability for our clients to benefit from price discovery, liquidity and transparency for both OTC and listed futures trading, in a single unified venue,” says Lam. On that note, SGX acquired BidFX to bring together both pools of liquidity to establish SGX as a one-stop venue for global FX OTC and futures participants. This allows the exchange to expand into a much larger global OTC FX market, and advance SGX’s global ambition to offer end-to-end FX platform and solutions. “In today’s complex trading environment, market participants also encounter multiple capital requirements, such as the uncleared margin rules which will fully be phased in two years from now. The UMR have imposed another regulatory burden that further deters trading activity, by requiring firms using OTC derivatives to post margin on transactions.
FlexC FX Futures was our first solution offered to clients to help them manage UMR,” says Lam. FlexC futures offers market participants the ability to trade customisable FX futures in an OTC manner, and clear trades on SGX’s platforms. With FX markets moving towards central clearing, FlexC FX Futures offers a more effective way of mitigating counterparty credit risk while retaining bilateral trading relationships, and expanding opportunities for improved Asian FX price discovery and risk management workflow. FlexC also significantly lowers costs of trading for SGX’s clients, as trading in the futures format only requires a one-day margin period risk.
Separately, SGX has also launched a new USD/INR futures product that allows NDF market participants to trade listed INR futures in the OTC format. This new Indian rupee futures contract is denominated in US dollars, with IMM expiry similar to the OTC format. “We have seen a lot of interest from buyside customers prior to the launch and since then, the contract has achieved a market share that exceeded 80%, with more than US$3 billion traded in the month of February. This product complements the market-leading SGX INR/USD FX futures (IU), and with cross margining benefits of up to 80%, it would add to the ecosystem of SGX Indian Rupee offerings,” says Lam.
In Latin America, The Mexican Derivatives Exchange (MexDer), part of the BMV Group, has been working on bringing to market a number of technology offerings in order to boost connectivity options for international participants. These include adding ION Fidessa and Trading Technologies FIX Order Routing in 2020. These are in addition to the Brazilian-based CMA, Mexican-based Comunytek and FIS Global GL Win FIX Order Routing options. MexDer also has a NY5 Point-of-Presence (POP) at the Equinix data center located in Secaucus, New Jersey, and co-location at the KIO data center where our transaction matching engine is in Mexico City.
“We are also spending time educating the international and local marketplace on benefits of the MexDer MXN Peso / USD Futures & Options as not only for “Best Execution” but also as an “Arbitrage Opportunity” to the CME Mexican Peso Futures, Daily Spot and OTC Forward Contracts. More futures are being traded than ever before,” says Gary Flagler, head of international business development at MexDer. The exchange’s MXN/USD futures traded over $1.2 trillion MXN Pesos in total notional value, a +20.9% increase in 2020 over 2019. Its smaller contract size of US$10,000 has allowed participants more precise hedging and including the clearinghouse, trading fees are competitive, too.
Looking ahead, MexDer is currently soliciting feedback from active FX proprietary traders to develop new Market Making and Incentive Programs to further expand its MXN/USD futures volumes and liquidity in 2021. Some natural market forces are helping bring additional volume to the exchange. Not only is the Mexican Peso one of the most traded currencies in the world, the third most traded in the Americas and the most traded in Latin America, but high yields offered in Mexican interest rate instruments in a near zero global rate environment have attracted international cash flows, thus increasing the exchange’s MXN/USD futures trading volume.
“The bottom line is there is now more demand for central counterparty (CCP) risk versus bilateral trading because of capital requirements. ASIGNA, the Mexican derivatives clearinghouse, is a nationally rated triple A and ESMA approved CCP,” says Flagler.
The exchange’s MXN/USD futures traded over 5,917,076 contracts in 2020, up 13.89% from the previous year. The number of trades also increased to 7,368 transactions in 2020, a 16.53% increase over 2019 transactions. On the technological front, MexDer is using the standard FIX protocol, version 4.4. The Mexican Derivatives Market has a redundant infrastructure and contingency facilities to ensure a flawless execution of every trade.
“We constantly fine-tune our systems. MexDer also leverages off third-party, broker algos and buyside clients who have either built their own execution algos or use preconfigured out-of-the-box ones through ISVs like Trading Technologies,” says Flagler. In risk management, the Mexican derivatives clearinghouse, will be introducing a new proprietary CVaR Margin Methodology, or expected shortfall, to the marketplace beginning April 12, 2021. This will replace the current Theoretical Intermarket Margin System, or TIMS, risk-based methodology created by the Options Clearing Corporation (OCC) that ASIGNA has been using since 1998. Internationally, MexDer is looking to attract international principal trading groups (PTGs), both banks and proprietary trading firms, to become MexDer Trading Member Firms in 2021, too.
As the deepest rouble liquidity pool in the world, the Moscow Exchange (MOEX) operates its trading platform for FX spot and derivatives and is focusing on further optimising its liquidity proposition. MOEX spot FX average daily volumes grew in 2020 by 28% year-on-year, driven by increased volatility from the pandemic and turbulent oil prices. Most significantly volumes grew in non-dollar currency pairs: CNY/RUB by 58%, KZT/RUB by 77%, TRY/RUB by 64%, GBP/RUB by 89%. FX future contracts also saw significant growth last year, with USD/RUB up 86% compared to the previous year and EUR/RUB up 95%. Against the backdrop of this volume growth, increased algorithmic trading and rising numbers of retail traders have reduced average ticket sizes to less than $100,000. This has made it less convenient to execute large amounts in a single trade and, when one sizable order may be executed by hundreds of different orders, it generates greater operational burdens and risks.
According to MOEX, most FX venues responded to these changing market conditions by reducing minimum size tickets, but MOEX opted to focus on flexible solutions for better execution by offering separate order books that better shape liquidity by size and spread for different types of market participants.
Large order books based on speedbump technology for tickets from $1 million plus provides an option with tighter spreads and solid liquidity that continue to develop rapidly. For larger tickets from $5 million upwards, MOEX has a new trading regime “request for stream” (RFS), suited for corporate and bank clients who need to execute large amounts, enabling them to request prices from a number of liquidity providers in private negotiation rooms.
The semi-anonymous board is equipped with new technology that enables tagging of clients or potentially, disclosure of name to not only provide best liquidity, but increase awareness of market impact, reports MOEX. The exchange’s oldest traditional order book, for trades best executed from $50K up to $1 million, is suitable for most participants and remains popular with clients able to seek better prices during numerous partial executions of larger orders by smaller clips. Small lots order book with minimum trade size of $1 has been developed for retail investors.
“Our innovative offering of order books and boards is possible because of one core advantage: post-trade clearing and settlement through the National Clearing Centre (NCC), our central counterparty (CCP) that sits within MOEX Group,” says MOEX managing director Igor Marich. “This flexible solution offers the best liquidity for various sized market participants, and based in its success, we plan to expand the offering during 2021.”
In another strategy designed to boost liquidity, MOEX has extended its trading hours and began trading FX, derivatives and precious metals three hours earlier on March 1, 2021. The extra morning session runs from 7 a.m. – 10 a.m. Moscow time, which means the MOEX FX trading day extends almost across the globe, from very eastern located Australia and finishing late with western US states. The morning session aligns MOEX with changing market dynamics moving toward international FX venues providing matching services 24 hours a day.
“There is growing demand for rouble instruments among investors from Southeast Asia, primarily from China, India, Singapore, Hong Kong. The morning session meets this demand and is expected to result rising volumes with the yuan as the expanded trading hours boost trading volume between Russia and China,” says Marich. “The launch of our expanded trading hours supports the further introduction of Asian investors into Russian equities and bonds by enabling currency conversion beforehand, locking in FX risk.”
In addition to expanding its international footprint, MOEX is expanding and enhancing its OTC clearing service through NCC. The exchange’s CCP has traditionally provided centralised clearing for all FX spot and derivatives trades executed at MOEX, a successful model that supported the stable function of the domestic RUB FX market. In parallel, central clearing has become more prominent, driven by the EMIR regulatory requirement that standardised derivatives clear via CCP and through global FX market momentum behind managing settlement risk to ensure the stability of a robust and liquid FX market.
This is outlined in Principle 50 of the FX Global Code: “Market participants should measure and monitor their Settlement risk and seek to mitigate that risk when possible.” MOEX launched centralised OTC clearing for rouble transactions last year to solve the challenges of insufficient or over-utilised credit lines and a global need for risk mitigation between counterparties in the rouble market.
Through an allocation of existing credit limit on MOEX, the service brings central clearing to trades between MOEX clearing members on external OTC FX platforms and provides the option of pre-trade checks in the core of this platform. Russian OTC e-FX platform NTPro became a pilot to run the new OTC clearing service with CCP. In 2020, MOEX acquired a stake in NTPro OTC platform owner BierbaumPro, which offers advanced technological solutions for liquidity aggregation, matching and algo execution across a wide range of FX instruments. In addition to settlement risk mitigation, the exchange’s central clearing service provides single collateral for on-exchange and OTC FX trades, cross-margining and netting of on-exchange and OTC trades, familiar procedures via the FIX infrastructure for clearing reports. All information in a transaction’s status – whether accepted for clearing or not – is contained within the terminal of the OTC FX trade platform. In the future, the service may be linked to other foreign external OTC platforms that trade and clear rouble FX instruments.
“Given the tremendous success of NTPro in gaining market share, we think that our joint product offering of both on-exchange and OTC solutions will continue to position MOEX as a market-leading global provider of the ‘one package’ marketplace for rouble FX pre-trade, execution and post-trade services,” says Marich.