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23 Apr 2024

Eurex | Eurex Clearing

Integrating FX futures in a hybrid world

This is the second in a series of articles outlining the current views on FX futures. Subscribe to FX News to receive upcoming articles and updates!  

Tobias Rank, Head of FX Product Sales at Eurex, looks at how a growing number of OTC FX market participants are using exchange-traded FX futures to optimize their portfolios from a capital and funding perspective.  

The foreign exchange (FX) market is going through a transitionary phase following on the heels of regulatory changes related to The Standardized Approach for Counterparty Credit Risk (SA-CCR) and Uncleared Margin Rules (UMR). Market participants are looking into ways they can integrate FX futures into their execution models, what the role of FX prime brokers should be when it comes to FX futures, and how platforms are incorporating exchange-traded derivatives into existing workflows. 

Buy-side: Favoring OTC style trading models to execute FX futures 

Over-the-counter (OTC) FX trading has long been characterized by bilateral and disclosed trading models, which rely on deep liquidity provided directly by FX dealers. Unsurprisingly, as buy-side firms transition from OTC to listed FX markets to optimize portfolios, they tend to favor these OTC-style trading models to execute their FX futures as well. 

One notable approach involves block trades or exchange for physicals (EFPs), which both empower buy-side firms to execute FX futures directly with their dealers. By leveraging existing FX relationships, these firms can source liquidity directly from FX dealers. This dual benefit allows for trading in any size, while ensuring transactions occur within fully cleared FX instruments. The goal? Optimizing portfolios while navigating funding, capital, risk and operational constraints. 

Moreover, this transition doesn’t necessitate an ISDA agreement or credit support annex (CSA) when adding new trading counterparts. Instead, buy-side firms can seamlessly expand their network without cumbersome paperwork. 

In this context, the exchange’s central limit order book (CLOB) serves as both a reference market and an additional source of anonymous liquidity, enhancing the overall trading landscape. 

Sell-side: Maintaining direct client relationships  

Sell-side futures execution desks play a pivotal role in the ever-evolving landscape of FX markets. Sitting at the forefront in providing FX futures services to clients, these desks offer execution and transparent risk pricing. Through block trades, execution desks facilitate risk transference to clients, typically on a request-for-quote (RFQ) basis. The ongoing trend of futurization in FX markets presents a unique opportunity for futures execution teams to expand their FX market share by servicing new client segments that have traditionally relied on uncleared FX instruments.  

In more recent times, also the voice- and electronic FX desks on the sell-side have proactively embraced FX futures. Their strategic focus now centers on providing highly automated execution services that seamlessly connect the OTC and listed FX markets, often facilitated by EFPs. By introducing these innovative hybrid trading models, clients gain efficient access to OTC FX spot liquidity through algorithmic trading when establishing FX futures positions. This strategic move not only reduces bank capital charges, but also enables sell-side firms to sustain their business models, characterized by high trading volumes and narrow margins. 

As a result, the sell-side is progressively incorporating these off-book FX futures execution models into their overall FX service offerings for clients. 

FX prime brokers: Providing access to FX futures markets  

Traditionally, buy-side firms have gained access to exchanges' clearing houses through clearing brokers. However, the landscape is evolving due to the growing futurization trend, and FX prime brokers (FXPBs) are now playing an increasingly pivotal role in facilitating access to FX futures. 

FXPBs not only enable access, but also take a holistic view of risk. When offering margin financing, FXPBs might consider risk stemming from both OTC and listed FX positions. This comprehensive approach enhances risk management and can significantly reduce funding costs for clients.  

When compared to intermediation in bilateral FX markets, FX futures trades offer several advantages for the FXPB. They are fully collateralized with initial margin and variation margin, ensuring robust risk coverage. Additionally, the counterparty risk associated with the dealer leg is effectively mitigated through the clearing house, thereby reducing the risk for the FXPB when dealing in FX futures. 

As the futurization of FX markets continues, the relevance of FXPBs grows, making them indispensable partners for buy-side firms navigating this dynamic landscape. 

Platforms: Integrating FX futures into OTC workflows 

OTC FX venues like 360T have started bringing FX futures onto their platforms. For clients, this often entails a simple product enablement to include listed FX futures in existing OTC FX workflows. This enables market participants to trade FX futures in a highly automated, electronic, and bilateral fashion – in the same way they trade OTC FX.  

This complements the FX futures offering on single-dealer platforms and enables buy-side firms to request prices from their preferred dealers in competition. Additionally, it empowers buy-side firms to transact directly with their preferred dealers, which aligns with the practices they’re accustomed to in OTC markets.   

The hybrid approach to FX futures 

In the dynamic world of FX, innovation is being driven on both the buy-side and sell-side. Notably, market participants are increasingly exploring FX futures instruments and integrating them into their bilateral relationships. 

The convergence of OTC and listed FX markets has given rise to hybrid trading models. Buy-side firms can now harness the advantages of both realms.  

Combining OTC and ETD liquidity pools, exploring new liquidity sources and optimizing portfolios are the key themes that are motivating change.  

But while FX futures are increasingly adopted, market participants form the buy- and sell-side maintain consistency across their trading practices. Bilateral trading relationships and the same standards of automation established in OTC FX markets seamlessly extend to the listed FX markets, ensuring a unified trading experience. 

How Eurex is supporting this development  

Eurex actively embraces the growing participation of OTC FX market players utilizing FX futures. Our ambition is to establish a market structure for listed FX derivatives that fully acknowledges the bilateral dynamics of OTC markets.  

To achieve this, we have introduced a dedicated offering designed for the bilateral trading of FX futures, which operates independently of the CLOB. There is a growing number of FX dealers offering liquidity to clients on a bilateral basis outside the CLOB. And we collaborate with several multi-dealer FX and RFQ platforms to integrate Eurex FX futures. Notably, successful integration has already been achieved with platforms such as 360T, RFQ Hub, and Eurex EnLight.  

Importantly, Eurex allows trading outside the CLOB without imposing a minimum trade size requirement, and we have set an attractive fee structure for such trades. Furthermore, we provide dealers with a simple set of rules to facilitate the registration of bilateral futures trades. 

We therefore aim to drive the electronification and innovation in FX futures together with the broader market to support the increasing transition of OTC FX users towards listed FX instruments.

This is the second in a series of articles outlining the current views on FX futures. Subscribe to FX News to receive upcoming articles and updates!  

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