Managing scarce financial resources is a growing challenge for FX market participants, who are under pressure due to a range of factors – from rising trading costs and increased regulation to complex, inefficient operational and workflow processes, internal competition for resources, fragmented data, and legacy technology.
Shrinking investment expenditure requires everyone to do more with less, making the choices of where to spend ever more critical – particularly in attempts to improve returns.
With the vast majority of the FX market remaining bilateral since the financial crisis, unlike many other markets, regulators have used alternative approaches to encourage participants to clear trades at a central counterparty (CCP). The implementation of SA-CCR and Uncleared Margin Rules (UMR) has materially diluted returns for uncleared trades, mainly on the sell-side.
But this dilution has impacted the buy-side as well – through pricing and access to credit lines. Firms continue to explore ways to optimise their capital footprint and lower margin costs to ease the financial pressures imposed by SA-CCR and UMR.
So, how can participants increase financial resource efficiency?
The key to FX trading efficiency
With limited resources to build bespoke solutions that drive efficiencies, being able to reduce capital and margin costs in the simplest and most cost-effective manner is critical. The key to this is CCP clearing.
The simple power of a CCP is the multilateral netting achieved over the bilateral, fragmented ecosystem when it comes to both margin and capital (and credit lines). Add to that the lower margin requirements vs. bilateral, and clearing typically delivers reductions of 70% in NDFs and FX options, which are both in scope for UMR. Better offsets are achieved by consolidating multiple counterparties down to a single CCP, along with more favourable modelling/weighting.
The other main financial benefit of clearing is a reduction in capital requirements. SA-CCR, on a relative basis, has hit FX particularly hard, as it is calculated at a counterparty and currency pair level. This makes it difficult to optimise bilaterally given the high turnover of the asset class, number of participants and currency pairs, and the network needed to achieve material and lasting benefits.
After the initial multilateral netting benefits, simply facing a CCP (without having to engage in bespoke processes or find offsetting counterparties) reduces the counterparty risk weight by at least 90% (the best bilateral counterparties are 20%+ whereas a CCP is only 2%). For risk-weighted asset (RWA) calculations, clearing FX represents a significant optimisation opportunity by reducing capital and margin costs.
And of course, facing a CCP in a multilateral netted manner frees up credit lines to conduct more business elsewhere.
Innovating to expand the FX clearing ecosystem
FX forwards
To enable market participants to overcome these barriers, LSEG Post Trade’s LCH ForexClear, SwapAgent, and Quantile businesses worked closely with market participants to develop an innovative ‘FX Smart Clearing’ solution to help reduce capital and margin costs across entire FX portfolios.
A key first step towards wider clearing of FX swaps and forwards, FX Smart Clearing helps solve capital challenges by enabling banks to clear their FX forward trades through a CCP in an optimised or selective manner. Netting exposures and facing a qualifying CCP reduces the SA-CCR exposure, lowering capital requirements vs. equivalent bilateral positions, for both RWA and the leverage ratio (LR) calculation.
Launched in November 2023, the service now has seven clearing members and has completed nine runs. From October 2024, it has been available as part of Quantile’s frequent FX capital optimisation runs. In 2024, the service cleared US$35bn notional, with volumes expected to increase as more members join in Q1 2025. For an in-depth discussion of FX forwards clearing, read our Q&A.
Non-deliverable forwards (NDFs)
For more participants to benefit from FX clearing, it needs to be as commercially compelling as possible and an integral part of FX trading. LCH ForexClear already clears approximately 25% of the NDF market (when looking at the 2022 BIS FX survey). The integration of clearing into LSEG’s NDF Matching central limit order book (CLOB) platform enables easier access to the full book of liquidity in the venue, for all participants, and better market transparency.
As the first FX NDF trading platform that offers pre-trade intent to clear trades, NDF Matching provides lower-cost execution and combines the liquidity, operational, and capital benefits of an NDF CLOB and clearing. We anticipate this will help to further boost and diversify FX liquidity – delivering a simpler, safer, and more efficient market for all participants.
FX options
The growth in FX options clearing has been nothing short of extreme, with cleared volumes up 100% vs 2023. As a product subject to UMR, it was the natural next step after NDFs, and with the multilateral netting and portfolio margining benefits achievable against an already large pool of risk from NDFs, understandably volumes have been growing. Additionally, given the G5 currency pair dominance in FX option volumes, it provides a natural offset to further boost the capital benefits that can be achieved by FX Smart Clearing for FX swaps and forwards.
What’s the outlook for FX clearing?
FX clearing at LCH ForexClear continues to gain momentum, as more participants onboard and use the service, alongside established members and clients, driving record clearing activity throughout 2024 – notably in FX options, supporting the ongoing electronification of this market.
More participants and higher volumes help build a larger liquidity pool, increasing opportunities for multilateral netting, while reducing margin, capital footprint, and counterparty credit risk.
We look forward to launching new solutions developed in collaboration with our market partners. These include a current project with CLS that will remove silos between cleared and bilateral settlement, making it more efficient for banks to onboard to the CCP and creating significantly greater netting benefits.
In a cost-conscious environment, where financial resources are scarce and optimisation is critical, FX clearing holds the key to boosting post-trade efficiency.