A member of
Eurex
FX clearing has long been touted as the next big thing for the listed world. Eurex talked to André Besant, Managing Director / Head of Foreign Exchange Germany at Deutsche Bank, on the progress to date and why a hybrid world might be the future.
It is fair to say that, to date, proponents of centrally cleared, exchange traded FX has been disappointed. Where are we on that path today?
AB: While clearing FX and trading exchange derivatives has made progress over the past few years, it has not yet taken off. The reasons vary by product and Covid-19 has certainly not helped in accelerating the process. The current main cleared offering is in the market for Non-Deliverable Forwards (NDFs) where we see a considerable amount of volume that is being cleared. However, in other parts of the market, bilateral trading is by far the most dominant choice.
The motivation to trade more on exchange and to clear ultimately comes down to the cost of doing so vs the bilateral world. You also need to take into account important factors such as the available liquidity in the market and the completeness of the product offering including currencies and the settlement process.
How do firms calculate the cost of clearing vs bilateral?
AB: The costs of clearing and the level of complexity involved in calculating them are different for each customer. Every customer is unique and certain customers will see a larger benefit in terms of netting and metric benefits such as capital savings, leverage ratio exposures and counterparty exposure reduction etc. This all needs to be analysed in detail. It is not the case simply to say that clearing is a no-brainer. It is a mathematical equation and one that is different for every firm.
The Uncleared Margin Rules will bring a lot more funds into scope for margining uncleared trades. The question remains whether the FX market can provide a cleared FX trade a price-point that is comparable to a bilateral trade today. A compelling offering is of critical importance to achieving broad acceptance in the market.
The interplay of upcoming regulatory change such as the UMR or other drivers such as SA-CCR are sometimes in conflict in terms of clarity. These rules come into effect in phases and there is a great need for education to help firms navigate through these changes and understand how they are impacted.
It is valuable to have new market participants come into FX and help the market develop in a sophisticated way. Having said that, in my view banks will have to service both segments so a hybrid model will be desirable when the interplay between the two segments becomes more efficient.
Common benefits like netting or improved netting sets are per se a good thing. If more common positives are found, then it is likely the journey will be accelerated. On the other hand, customers that use a prime broker already benefit from netting and will need to go through the scenario analysis to analyse how their portfolios will behave in a cleared environment.
Aside from price, what is holding back the transition to clearing?
AB: The incomplete product spectrum in terms of currencies and other muting effects such as a lack of liquidity in certain markets or higher settlement costs are holding parts of the market back from switching to cleared products. For certain products such as deliverable options, it is important to think the settlement process through in detail especially in cases involving the delivery of foreign currencies.
Bilateral FX on the other hand can rely on a very high volume and established infrastructure including settlement. This is a very important factor. Many market participants prefer this defragmented setup over central cleared environments.
Ultimately, however, for every future scenario it is in everyone’s interests to guarantee operational resilience in any parallel process. For many clients, changes in the market will result in two different operational processes.
In my view, a hybrid model is a realistic future scenario. In this world, the ability to meet customers’ needs and respond quickly to regulatory requirements is the key driver for success. Being able to offer smooth solutions around product offering, margining and settlement is the fundamental building block to success. We at Deutsche Bank stay close to market developments and are supportive of all efforts to achieve best practice in the hybrid world.
What impact is regulation having on the market?
AB: New regulations from UMR to SA-CCR are coming in phases and the market will therefore most likely adjust in phases as well. More and more participants will come into the clearing segment as the rules become more applicable to a wider spectrum of funds.
Once this happens, there is a chance to achieve critical mass. What is important is how quickly the process will happen. Due to different treatment of legacy portfolios vs new portfolios, firms will potentially need to manage two operational processes with the associated costs, which will have an impact on the pace of adoption.
What is the future for FX clearing and where might the market ultimately end up?
AB: All in all, I don’t see a total move towards the cleared segment but there is a strong argument that the ratio of trades being cleared may well go up. The sooner the market gets clarity on the individual impact of each phase of the rule changes, the sooner the market can adapt and develop efficient solutions. It is important to understand each instrument’s reporting and IM requirements and what impact they will have across a portfolio. Firms need to take that into consideration.
What role is automated trading and electronification playing?
AB: Automated electronic trading is already the dominant standard in some areas but remains a work in progress in others. For example, around 95-99% of the spot market is electronic today.
The goal of electronification is to reduce costs and operational risk in lifecycle management of each trade. This goal will not change and any new technical setup needs to be compatible with both channels. This means that more complete solutions will need to be developed to incentivise clearing of trades. The bottom-line is that price wins the day, which is even more of a central point when you take into consideration the continued electronification of the market.
We look forward to discussing these and more topics at the upcoming Derivatives Forum Frankfurt on 23-24 March.
Market Status ⓘ
XEUR
The market status window is an indication regarding the current technical availability of the trading system. It indicates whether news board messages regarding current technical issues of the trading system have been published or will be published shortly.
Please find further information about incident handling in the Emergency Playbook published on the Eurex webpage under Support --> Emergencies and safeguards. Detailed information about incident communication, market re-opening procedures and best practices for order and trade reconciliation can be found in the chapters 4.2, 4.3 and 4.5, respectively. Concrete information for the respective incident will be published during the incident via newsboard message.
We strongly recommend not to take any decisions based on the indications in the market status window but to always check the production news board for comprehensive information on an incident.
An instant update of the Market Status requires an enabled up-to date Java™ version within the browser.