FX Clearing: A future full of promise

May 2023 in Supplements

Conversations around FX clearing have gathered momentum recently, but much remains to be done before it becomes standard practice. A lot of development will naturally come from regulatory forces. James Pearson, Head of ForexClear at LCH lists a few regulatory drivers that might potentially turn FX clearing into an industry norm.

“The focus on clearing as a solution to UMR obligations, SA-CCR requirements as well as counterparty credit risk management and optimisation, has magnified the benefits of clearing and provided the impetus needed for continued and concentrated engagement from market participants,” he says. “We envisage this continuing with existing members and clients, as well as new ones.”

In many ways, the benefits clearing offers make it an obvious solution in the markets. As Pearson explains, “Market access, eradication of credit line constraints and, therefore, competitive advantage, require a cleared flow. Cost savings – whether from reduced funding from increased margin efficiency or the opportunity cost of capital – will become far more transparent, as the actual cost of trading will change. Clearing will also result in an enhanced bid-offer spread. Efficient markets dictate that clearing will improve pricing, and then the benefits of clearing will be visible to all in real-time.”

Despite these obvious benefits, implementing clearing will likely take some time. FX boasts a well-established infrastructure with deeply embedded workflows. New services have to take all these into account, lengthening the time to delivery. For their part, Pearson says that LCH ForexClear is highly ambitious, but is conscious of needing to take deliberate, incremental steps to achieve its goals.

“We are currently investigating expanding the currencies and tenors available for clearing,” he says. “Alongside this, we have ongoing work to allow us to offer a scalable deliverable forwards offering, first to our members and then to clients. We are doing this with a solution-driven mindset, ensuring that the product is not just available but also relevant. Clearing will therefore be selective, based on parameters that can be chosen by the clearing party to suit their needs and produce the optimal solution to their management of financial resources.”

He notes that the firm’s focus is implementing a deliverable forward solution before anything else. “We would hope to be able to follow deliverable forwards clearing with a possible cross-currency swap solution. At the same time, we are also always open to considering further new concepts, such as spot clearing, if it benefits the market,” he says.

While clearing is currently a post-trade activity, expanding its footprint to pre-trade activities will undoubtedly bring additional benefits. Pearson notes that LCH ForexClear’s long-term aims align with this view. “We are very focused on building a long-term clearing solution that is embedded in the market and in participants’ workflows, and we see engagement in the wider post-trade clearing offering as the key to establishing the broader footprint of the clearing ecosystem,” he says. “Equally, we are aware that we need to ensure that the clearing journey is as efficient as possible, minimises costs of doing business and really highlights the benefits of clearing to all, such that in time, the market develops a cleared versus uncleared price.”

And how would he increase confidence in clearing outcomes? “We need to embed the clearing decisionmaking process as the first step in the execution journey and in the wider market structure,” he answers. “This has to mean that trades are executed in the knowledge that they will be cleared. The first step on that journey, now that we have established the NDF interbank market cleared by LCH ForexClear, is to offer a pre-trade ‘intent to clear’ execution offering.”

Pearson notes that LCH ForexClear is partnering with LSEG FX to launch NDF Matching*, a pre-trade intent-to-clear central limit order book (CLOB) that will be the first to allow the market to determine a cleared NDF price. “We hope that we can participate in additional execution venues over time and expand the product types that can be priced on the basis of an intent to clear,” he says.

While time will tell how clearing progresses in FX, current developments undoubtedly point to a more sophisticated and efficient process shortly. *Workflow that NDF Matching will offer is subject to regulatory approval.