It is rare that market developments end up benefitting all participants, buy-side, sell-side and execution venues. However, FX futures appear to be close to achieving that. At the centre of FX futures’ appeal to the market is the concept pf a hybrid trading model that combines the flexibility of over-the-counter (OTC) bilateral trades with the transparency of exchange-traded instruments.
This is especially appealing to buy-side participants such as asset managers, pension funds, insurance companies and commodity trading advisors (CTAs). A survey commissioned by Eurex and conducted by WBR Research found that 95% of buy-side respondents are already integrating FX futures into their current trading strategies. Furthermore, more than three-quarters of that group are conducting as much as 30% of their FX activity through FX futures.
The survey attributes several push and pull factors to the growing adoption. For example, enhanced market access, evolving market sentiment and regulatory considerations have been key attractions. At the same time, the traditional OTC method of trading has incurred several challenges in recent years, including the cost of uncleared margin rules (UMR), liquidity issues and the capital requirements facing sell-side firms which are then passed onto the buy-side.
Another major attraction of FX futures to buy-side participants is the fact that they can continue to use the bilateral trading model that is a mainstay of the FX market. The Eurex report found that this is the preferred trading model for buy-side firms, executing directly with their trusted FX dealers. Block trades are the favoured execution model while there is also a growing interest in exchange-for-physical (EFP) instruments.
“We have continuously expanded our share in FX futures due to our general preference for listed and centrally cleared derivatives,” states Rico Milde, head of FX trading at German investment firm Union Investments, who was one of the survey respondents. “FX futures provide operational and regulatory benefits over OTC FX instruments. As such, we are not surprised about the increasing utilization of listed FX derivatives in the current market environment.”
“Any platform or product that connects the bilaterally traded Spot FX market with the cleared FX market will help to drive greater participation in the FX futures market,”
Tobias Rank
These trends also have some operational implications – namely a need for greater automation and better bilateral workflows. “Our survey indicates a strong preference among buy-side firms for integrating FX futures into their OTC FX execution management systems (EMS),” states the report. “Such integration would streamline workflows and consolidate trading activities onto a single, efficient platform. Although not all platforms are currently equipped to support FX futures, the trend is clear: there is a burgeoning demand for a unified EMS capable of managing the entire spectrum of FX transactions.”
Operational challenges
There has been a greater uptake of FX futures in recent years because of the challenges on the buy-side in the OTC market, such as the impact of Uncleared Margin Rules (UMR), availability to liquidity and trading counterparties, and operational challenges such as transaction cost analysis (TCA), manual processes and data issues, says Tobias Rank, head of FX product sales at Eurex. “There is also the indirect impact from the standard approach to counterparty credit risk (SA-CCR) that determines capital requirements for banks which are then being passed on to buy-side clients.”
For some buyside firms, whose banks adjusted their pricing in light of the capital requirements, the impact was immediate. But other banks took some time to adjust their pricing, which means the market is taking some time to address the issue collectively.
And more often than not, market participants opted for a temporary workaround while assessing more permanent solutions. For example, many trading firms employed manual position monitoring frameworks to stay under relevant threshold when UMR requirements came into full force in 2022. As Rank says: “Eurex provided various solutions in the space of FX clearing but it took the market a while to find and agree on more permanent solutions.”
One such solution was FX futures – an asset class that could address firms’ regulatory challenges in terms of capital requirements and bilateral margin requirements but also provide access to the liquidity that buyside firms are looking for and help ease operational challenges. Consequently, FX futures have thrived.
“As the use of clearing frees up bilateral credit and settlement lines, this can increase the scope of available OTC trading counterparts as well as existing limit utilisation.”
David Holcombe
“Our volumes for FX futures have increased by 50% and open interest has grown by 80%,” says Rank. “It is still a nascent product but can feel the trajectory across all market participants. We are also recruiting more participants. We have onboarded another 10 clearing brokers since 2023 making a total of 22, added 6 FX dealers as liquidity providers for bilateral trades and have grown the network of on-screen liquidity providers.” For Eurex, the goal is to replicate the OTC FX market structure in an exchange-traded environment. With this approach in mind, Eurex aims to protect bilateral relationships while offering access to liquidity of OTC counterparties and OTC markets. Hence, Eurex aims to connect to all relevant FX dealers and FX platforms, including multi dealer platforms. The German exchange has formed a formal link with 360T after it was acquired by Deutsche Boerse in 2015. The aim at the time was to put 360T at the “centre of competence of Deutsche Boerse Group’s global FX strategy”.
Subsequently, 360T has become a key presence in the hybrid trading model that has developed in the last couple of years, alongside the growth of the FX futures market. Any platform or product that connects the bilaterally traded Spot FX market with the cleared FX market will help to drive greater participation in the FX futures market, says Rank.
“The FX futures market is following established processes,” says Rank. “The combination of cleared and bilateral trading properties means FX futures will become a permanent solution – as proven by other asset classes. The traditional exchange market is order book-driven. But with 360T we recognise the role of bilateral trading for the buy-side so we have tried to cater for that with the market model and rulebook which we have introduced,” says Rank. These measures are intended to enable bilateral trading between counterparties to provide greater flexibility and choice to clients, something which Rank refers to as “the epitome of hybrid trading”.
Spot and cleared FX connections
There is a connection between spot and cleared FX futures which will definitely drive adoption of futures, argues Rank. This connection is also being seen within banks as well as on trading platforms such as 360T or exchanges like Eurex. “Banks have started offering truly hybrid execution models where clients can build positions in the FX spot market and transfer that position into FX futures. And we see that hybrid world also reflected within banks: It was traditionally the futures desks but now we are seeing the FX desk take a greater role and bringing their integration and automation capability. The futures desk has the futures execution and exchange know-how while the FX desks add OTC liquidity and automation,” says Rank.
This has also led to changes in terms of technology, says Rank. “The futures market has traditionally been voice-driven but eFX desks are looking for the same level of automation they offer elsewhere. Automated execution services on single-dealer and multi-dealer platforms like 360T are being offered to seamlessly connect the spot market and the futures market.”
According to Rank, the acquisition and integration of 360T within the Deutsche Boerse group has elevated it into a multi-dealer platform using multi-dealer workflows to both improve internal efficiency and to satisfy the operational demands of the buy-side.
However, while 360T’s success is welcomed by Eurex and any other part of the Deutsche Boerse group, Eurex is also working with platforms like RFQ-Hub and others. “We definitely encourage greater access and distribution, says Rank. “We may have developed a prototype with 360T but as a venue we remain agnostic.”
Despite the success of the hybrid trading model, there is still more work to be done to promote the benefit of trading FX futures and to develop the kind of tools and technology that will ensure the FX futures market becomes a long-term fixture of the market rather than a fleeting success story that rose from the challenges inadvertently created by post-financial crisis regulatory reforms.
For example, “The creation of orderbooks for exchange-for-physicals (EFPs) within FX platforms will be especially helpful for dealers to manage their positions across the market.”
Rank also expects to see an expansion of currency pairs and anticipates most exchanges to offer more flexible contracts which will, in turn, lead to a greater variety of trading styles. “FX futures have been popular for alpha generating and hedging strategies. But with customizable maturities, also trading strategies that require the delivery of currencies on a certain value date will become more popular. We will also see the growth of FX options on Eurex. After having established the FX futures market successfully, we expect to see more activity around FX options in the coming months.”
Regulatory drivers
According to David Holcombe, Head of Product for FX futures and Clearing at 360T, the main reason the evolution of the FX futures market has differed from the trajectory of other listed markets is regulatory-related. “The FX market has not faced a mandate to clear its most liquid products. While other markets have had a catalyst for revolution in terms of a cliff-edge implementation timeframe, the FX market has instead seen an evolution towards the use of Listed FX products to relieve the cumulative cost pressure from several years of different regulations on existing OTC models.” said Holcombe. “The onus on the FX market has been to look for alternative revenue streams and cost efficiencies. This has already brought structural change to many banks both on an organisational and technical front, integrating the use of FX Futures into the FX organisation, rather than these being part of a separate Listed Products division,” he says.
One product that has become especially popular of late has been the (exchange for physicals) EFPs.
The EFP comes from the commodities market as a transaction designed to convert between a futures position and its underlying. “In the context of FX, this is a transaction that can translate between OTC FX and the FX Futures market,” says Holcombe.
“This is highly relevant to the growth of FX Futures, because as a bilaterally negotiated trade existing OTC relationships and all OTC products can continue to be fully monetized, then use the EFP as an additional function to register those results onto the exchange, translating it into a cleared futures position.”, says Holcombe.
“As the use of clearing frees up bilateral credit and settlement lines, this can increase the scope of available OTC trading counterparts as well as existing limit utilisation. And as the EFP is an additive process to the OTC activity, it does not require fundamental change to existing OTC trading practices. Indeed, you can already see the EFP being offered to minimise the step from purely bilateral OTC FX into the world of centrally cleared and exchange listed FX products.” says Holcombe.
So why are futures more likely to integrate into the FX market rather than the other way round? While there are several positive arguments to using an exchange’s central limit orderbook, the flip side of the price transparency of everybody facing the same price when trading there can also limit the depth of liquidity available at any one point, meaning there is not enough for clients to achieve an immediate risk transfer price for the larger FX trades they need on a day to day basis. This is where the OTC market with relationships built up over many years, which is now offering a relationship trading model for FX Futures, can deliver what is required. The OTC FX market is expanding to gain and offer the benefits that use of Listed FX products can bring.”
Providing flexibility
So what can be done to enable more market participation in the FX futures market? There’s a number of things that exchanges can do, says Holcombe. “Futures are a highly standardised and defined product, and the buy-side who are used to the flexibility of OTC markets often need more flexibility on attributes such as value date, for example. Even though a client can now trade futures against a panel of banks in 360T just like they do in OTC FX, if they need a specific value date then existing listed products with standard monthly or quarterly expiries may not be a perfect fit where an exact hedge is required. Similarly with notional amounts, where Futures by design do not offer the full granularity available for an OTC FX trade.”
“There needs to be a better balance and I am not sure the market is quite there yet in terms of sophistication. It feels more like we are at the beginning rather than the end of this journey,” he says. “While the greater electronification of the off-exchange relationship market will help clients routinely flip positions between Futures and OTC FX, some exchange such as Eurex have a roadmap addressing this sort of thing via listed FX product enhancements.”
GLOBAL MACRO DRIVERS
Although transparency, cost of trading and capital requirements are often cited as the reasons behind the demand for FX futures, says KC Lam, global head of rates and FX at SGX Group, global macro drivers such as the growing stature of Asia economies underpin the rapid growth in SGX FX’s Asian currency futures.
For example, China as the second largest economy is too big to ignore, while India, the fastest growing major economy, has been a favourite among global investors with its robust growth, demographic dividend and political stability. Meanwhile, South Korea’s advanced economy and leading export sectors including semiconductors, consumer electronics and automobiles, are drawing investor interest, adds Lam.
With 2024 being a historic year for elections and monetary policy changes, hedging activity surged on SGX FX, the largest Asian FX futures exchange by volume and open interest (OI). SGX FX holds the largest international market share for USD/CNH, offshore Indian Rupee (INR) and Korean Won (KRW) futures.
“Liquidity begets liquidity,” says Lam. “In September, our CNH futures saw an 83% year-on-year growth in OI and over US$15.3 billion in daily volume. Our INR futures had nearly US$2 billion in daily volume and a strong OI market share. As the largest and fastest growing offshore KRW futures exchange, we achieved US$360 million in daily notional with volume growing 1.5 times and OI increasing fourfold.”
The volatile market environment this year has driven risk management to record highs. “Our success lies in our specialisation and focus on building resilient, liquid markets. During market stress and extreme volatility, investors rely on us for risk management, price discovery and price formation. The recent carry trade unwind shows we are the go-to venue for macro events,” explains Lam.
SGX’s USD/CNH futures, the world’s most traded international RMB futures, hit a record US$35.2 billion ADV amid market turbulence on 5 August, even higher than the US$33.5 billion ADV on 6 November post-U.S elections. Notably, during China’s Golden Week holiday, global investors continued to hedge on SGX FX with a US$21.3 billion ADV.
“During market stress and extreme volatility, investors rely on us for risk management, price discovery and price formation.”
KC Lam
“We track numerous metrics,” says Lam, “including the rising number of new market participants and banks trading SGX’s liquidity. They use our market data for price discovery, making it a good reference for trading the curve, especially with some of our contracts trade out to a year.”
Lam also highlights the interesting data point on the distribution of liquidity, noting increased activity from buy-side participants including CTAs, asset managers and hedge funds. “FX futures offer benefits such as greater transparency, sizable depth of book and round-the-clock liquidity. Many of our buy-side participants are from Europe and North America, particularly CTAs. The liquidity on SGX FX is global in nature – almost 40% of our liquidity occurs during the T+1 session, representing European and US hours.”
Another reason for the continued growth of SGX FX futures are new products and trading models that connect OTC FX spot markets with cleared FX futures. SGX FX aims to provide market participants diverse options in platforms, venues and trading types, while ensuring new offerings complement rather than compete with banks’ services. “We always collaborate with clients to develop new offerings that enhance the trading ecosystem.”
Lam explained how SGX responded to market feedback to reduce basis risk between OTC FX spot prices and FX futures. To increase efficiency and reduce friction for OTC FX traders, SGX changed the timing and the reference for the Final Settlement Price (FSP) of its flagship USD/CNH futures. This change led to increased volumes on the last trading day, rise in OI and more block trades executed against the FSP. “Customers trading OTC FX spot, forwards, or options in USD/CNH can now hedge via our USD/CNH futures and options seamlessly and efficiently. We also facilitate price discovery and liquidity management across Asian and European time zones,” says Lam.
According to Lam, innovation is key to the continued growth of the FX futures market. “Regulation ensures market fairness and orderliness, and benefits both OTC FX and listed futures. Studies have shown that the growth of FX futures complements OTC FX growth,” says Lam.
“SGX FX expanded into the OTC FX market by acquiring BidFX and MaxxTrader, becoming Asia’s leading venue for risk-managing and trading major currencies across FX instruments. We are now the only FX futures exchange in Asia with an OTC FX trading venue and a full OTC FX technology stack for workflow electronification and automation. Our aggregate OTC and futures volumes have reached unprecedented highs, culminating in a record high trading volume in September – $168bn a day. We expect to see continued growth for combined OTC and listed FX venues,” says Lam.
On the outlook for currencies, Lam anticipates asset rotation into Asia due to its relative affordability compared to US equities, while the strong policy support and stimulus has made it more attractive. “Asian currency futures are ideal for trading macro views in a changing global environment, pointing to a brighter future for FX futures,” concludes Lam.
