Eurex, Eurex Clearing
Phase 5 of the Uncleared Margin Rules (UMR), which came into effect in September 2021, is expected to drive buy-side demand for FX futures and OTC FX clearing since these offer a viable alternative to the bilateral OTC market. However, UMR and FX is a complex story. To understand it in full, we asked Archana Varshney, Head OTC FX Sales and Business Development at Eurex, for an explanation that was as simple as possible.
Archana, how is FX affected by UMR?
The key takeaway is that, except for FX spot, all FX bilateral exposures such as non-deliverable forwards (NDFs), FX forwards, FX swaps, FX options and hybrid FX products like cross currency swaps, are captured and count towards a client’s Average Aggregate Notional Amount (ANAA) threshold calculation.
However, there is a caveat for FX products: even though all products are relevant for the ANAA calculation, only non-deliverable forwards and FX options require regulatory bilateral margins to be posted.
But, as a further quirk in the rules, credit intermediaries may need to pay variation margins on the full scope of FX products! What this means in practice is that clients can be brought into the scope of UMR by virtue of their FX products, despite not needing to post margins on these products. However, once in scope, they may need to post margins on their fixed income and equity products. Clients should be looking holistically at exposure management and the solutions available.
What solutions can Eurex offer for NDFs and FX options bilateral margins?
Due to the requirement for bilateral margins, NDFs and FX options are key products for clients to consider. Eurex has solutions for both products, and volumes have shifted into clearing as part of the earlier waves of UMR.
On the NDF side, we will – subject to regulatory approval – offer clearing of the most liquid NDF currency pairs by Q4 2021: non-deliverable USD/BRL, USD/KRW, USD/INR, USD/TWD, USD/CLP and USD/IDR. The key benefits of centrally clearing these products is the lower margin period of risk (five versus ten days) and the multilateral netting capabilities, enabling the highest margin optimization.
For FX options, we’re in the process of launching a listed options market in the G7 currencies with a shorter margin period of risk (MPOR) of two days and the ability to transact on a regulated market. We are also continuing to improve the flexibility of these products, to allow OTC users to feel more familiar with trading them. To offer the potential for margin optimization we will also portfolio margin these products with FX futures.
What other benefits does clearing FX offer?
ISDA research in 2019 highlighted that 19 percent of respondents are captured by UMR solely on their FX exposures. As cleared FX, in particular FX futures, are liquid and available to clear today for both banks and clients, those affected by UMR are able to make use of these products to lower their ANAA exposures.
This allows counterparty limits to be used for some of the more exotic derivatives or indeed remove themselves from the scope of UMR. Given the legal and operational undertaking for setting up for UMR, cleared FX provides a strong, and importantly available, alternative for UMR compliance.
For those looking to maintain OTC trading, the Eurex Clearing OTC FX and cross-currency swap clearing service has just gone live, offering solutions for clients looking to clear deliverable OTC FX products. Although it may seem that clearing is expensive as initial margin needs to be posted to a clearing house, the trick is to have an optimized overall portfolio of all cleared OTC FX products, thereby optimizing the IM and getting all the benefits of clearing.
And finally, one benefit of central clearing that is less focused on UMR, but nevertheless very important, is that it offers a solution to the credit challenges seen in the bilateral FX markets. Using FX clearing in whatever form simplifies and strengthens the counterparty management process.
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