23 May 2022

Eurex | Eurex Clearing

The future of FX futures

Momentum is building for the adoption of FX futures, with regulatory impetus bringing the product’s qualities to investors’ attention. Eurex caught up with Scotte Moegling, Institutional Trading at Flow Traders to discuss the futurization of FX and the opportunities available in block trades.

How is the regulatory environment affecting your business?

The UMR and other regulatory regimes are interesting in that they can benefit Flow Traders, given our success in pricing block trades, which many institutions have or are planning on using as a substitute for FX Forwards.  The impetus behind this is that FX Forwards count towards AANA threshold calculations (not the margin requirements), thus utilizing FX Futures blocks provides institutions the ability to hedge in the same fashion without additional activity counting towards their UMR calculations. 

We are already witnessing this shift to an extent, with exchanges and ourselves seeing an uptick trend in FX Futures blocks recently.  We have observed requests coming in from new counterparties, and an increase in inbound price requests from historical relationships, which has translated into higher volumes as a maker in these products due to our competitiveness.

What is needed to increase this momentum towards futures?

Whilst these regulation requirements push firms (through UMR capital costs) to migrate their execution via FX Futures, the pull factor to drive additional momentum comes down to cost.  This is both in the form of fees, as well as the execution costs associated with the liquidity available to them on these exchanges.  I assume institutions have been performing appropriate assessments to evaluate these metrics, and as the phase roll-out of UMR has pressed forward the result has been that it makes more economic sense for certain firms to move into Futures for execution.  Naturally this increases the available liquidity on exchanges, and as this variable has changed it affects other institutions’ execution cost models making it more appealing for them to transition into futures whether they were already captured under UMR or not.

Another driving factor into the futures space which shouldn’t be ignored is the effects of SA-CCR, which US banks are having to deal with.  Banks are extremely sensitive to return on capital metrics, and judge each business line in isolation against it.  The SA-CCR calculation can be extremely punitive to directional clients, thus the return profile of such clients will be difficult to manage for certain business lines at banks (such as prime).  There is a limitation with operational efficiency that can be gained to minimize the impact of SA-CCR for such businesses, and it will come to a point where the only variable to toggle will be the fees they charge such clients.  This increase could come as an increase in prime fees or via bid-ask the bank is quoting.  This will factor into the aforementioned assessment firms are performing for their cost of execution, and if increased enough could make the futures market more appealing.

If this holds true, it would be another driver for liquidity to pick up in the futures space which could present a compelling argument for others to see the execution benefits over OTC.

What are the advantages of off-exchange block trades?

Block trades provide the ability for institutions to get large orders filled quickly and at a fair price.  Given Flow Traders experience in the futures space, and our position in the market, we are able to price blocks competitively which has been a benefit to our counterparty relationships.

Due to the fact that we have been doing this successfully for quite some time, and as this method of execution becomes more economically efficient for more firms, we hope to expand our counterparty base and continue to be a stable and competitive market maker in these products. 

For those who have entered the FX futures space, how has the experience been?

Although difficult to measure, the types of firms where it makes sense to execute via FX Futures begin to appreciate the transparency, lessened counterparty risk, and no last look attributes the exchange offers when they migrate over.  However, the biggest component in experience moving from OTC to Futures is liquidity which will vary depending on what you are trading.  Thus, the experience will differ between contracts and in some instances it will only makes sense to perform certain parts of their execution strategy via Futures and others OTC until the liquidity experience becomes sensible.