“The next steps in the evolution of clearing are likely to be centred on product enhancements to make the process even more automated for customers.”
Paul Houston, who was recently named to an expanded role as Global Head of FX Products at CME Group, speaks with Markets Media Group Senior Writer Julie Ros about the recent decision to more closely align the spot and listed FX businesses.
In August of this year, CME Group brought its OTC and futures businesses into a single unit for the first time. As part of this move, you were named global head of FX products, overseeing both listed and spot. What was the impetus to align the two businesses under a single product head at this time?
Paul Houston, CME Group
We’ve been working to create tighter alignment between the FX businesses since CME Group purchased EBS through its acquisition of NEX in 2018.
Following the successful migration of EBS Market onto CME Group’s Globex platform in May 2022, we now have a uniquely integrated global FX trading platform spanning futures and options, cash (OTC) and cleared FX, providing access to unparalleled price discovery, execution quality and transaction cost analysis to drive the greatest possible operational, margin, capital, and total cost efficiencies for clients.
Our new structure will allow us to better connect the cash and futures markets, significantly expanding trading opportunities for our clients, with an enhanced ability to introduce new products to the FX marketplace.
Can you explain the correlations (or otherwise) between FX futures and options and the underlying spot market?
In general, cash and futures prices are highly correlated. There are a range of participants who are active across both, which reinforces the alignment of pricing between the two and supports convergence of the prices around expiration and delivery of futures contracts. As a result, FX futures markets can serve not only as an efficient and centrally cleared means of managing forward-dated FX risk, but they can also be used as a highly correlated proxy for spot FX for participants who are willing and able to manage the basis risk. As such, we have developed the FX Link service to provide clients with a firm, transparent source of liquidity for FX swaps, allowing customers to seamlessly transition risk between the cash and futures markets, helping with margin optimisation and credit line utilisation.
Overall, this means that cash and futures liquidity sources – such as CME Group’s FX futures and EBS Market spot FX platforms – can be considered complementary to each other. Following the migration of EBS Market onto the CME Globex platform in 2022, clients can now access FX cash and futures liquidity in an even more efficient manner.
With FX Link, CME Group has created the first ever Central Limit Order Book (CLOB) between the OTC spot FX and CME Group FX futures markets. Last year, the exchange announced record volumes. Is 2023 keeping pace? What are the main benefits of trading in this anonymous, centralized FX swaps liquidity pool?
Delving into FX Link further, the product provides a tradeable basis between OTC spot FX and CME FX futures, with all pricing in the orderbook being firm, so no last look, and credit agnostic. It provides traders with a complementary pool of liquidity for FX swaps risk while also providing a tool to enable traders to optimise their risk between the cleared futures market and OTC spot FX.
Looking back at 2022, we saw volumes in FX Link increase 90% on the prior year, which helps to illustrate the growing relevance of this service. This is a trend that we have seen continue in 2023 with year-to-date volumes broadly in line with those of 2022. One of the primary drivers behind this growth is that FX Link creates the total separation of credit from liquidity, which helps to solve one of the largest sources of friction within the wider FX swaps market. The diverse and growing ecosystem within FX Link that spans banks, non-bank liquidity providers, hedge funds and corporates also helps to create a liquidity pool that complements the pricing flows in the OTC market.
How has trading been this year – for both spot and futures markets – in terms of volatility? Has inflation and higher interest rates played a factor?
Continued uncertainty around central bank rate decisions are material drivers of FX activity globally, and we have seen strong volumes in our most liquid core currency pairs as a result. For example, if we look at FX futures volume in October (month to date), it’s up 11% compared to the same period in 2022, with particularly strong activity in pairs including EUR (up 7%), JPY (up 28%), AUD (up 29%), MXN (up 115%) and BRL (up 36%).
In 2023, our FX futures and options business also achieved a number of records including our biggest ever trading day on 8 March when 3.1 million contracts with a notional value of $297 billion were traded. This was 5% higher than the previous record volume day in September 2022.
On the EBS side, total spot ADV in September was $53.4 billion which is reflective of reduced volatility in the market. CNH volumes remained strong, up 5% versus the same period in 2022.
Delving deeper into volatility levels in the FX markets, it’s important to recognise that 2023 has tailed off from the levels seen in 2022 when we finished the year with global ADV of $85.5 billion for FX futures and options – a 24% uptick on 2021, and an ADV of $65 billion for EBS – a 7% uptick on 2021.
Looking at our CME Group Volatility Index (CVOL) which measures forward looking volatility based on underlying CME Group options, there has been a marked year-on-year decline in FX market volatility with comparative FX volatility scores of 10.6 in 2022 versus 8.4 in 2023.
This of course makes for a more challenging trading environment, but with a number of new technology enhancements now live on EBS Market, including speeding up market data, reducing minimum quote lifespan (MQL), and the addition of new conditional price increments, we’re excited about the benefits this will have for our client base.
Where are you seeing pockets of growth in FX? How has the interest rate environment impacted EM currencies in particular?
We’re keeping a close eye on developments within the Asian FX markets. The recent announcement that South Korea will extend their onshore spot trading hours and allow certain offshore participants to access this market is something we’re keeping abreast of. Turning to developments in India, the recent change to allow onshore banks to trade NDFs is very interesting for us given our strength in INR NDFs.
Longer term, there continues to be an opportunity to further support the development of the electronic FX market in LatAm.
That said, the continued uncertainty of central bank rate decisions around the world, combined with a broader backdrop of other macro-economic drivers, has led to strong FX futures activity in both the Mexican peso, which is up 115% so far in October compared with the same period last year, and also the Brazilian real, which is up 36% in October, again compared to the same period last year.
More broadly, the impact of the current rate environment on emerging market currencies varies by country and the nature of their economies, which may often dictate that their currencies aren’t fully deliverable.
Over the past few years, there has been increased interest in NDF and swaps trading. Do you see continued growth in terms of demand for these types of instruments or is it more about improving processes?
According to the BIS Triennial survey, FX swaps represent on average 50% of the $7 trillion global FX market, and at certain times up to two-thirds of the total market. The large majority of this critical market remains traded on an RFQ or RFS basis and is inherently dependent on having credit lines in place (either directly with the liquidity providers or via prime broker arrangements). The higher interest rate environment has helped to create a renewed interest from customers in looking at their FX swaps activity and considering ways to optimise the trading.
A combination of FX Link and FX futures spreads provide complementary pools of centrally cleared FX swaps risk for both spot starting and forward starting positions – with the 23-hour orderbook showing prices out to 1y+. As previously mentioned, these cleared FX swap products are seeing material growth, and pricing the futures spreads is now consistent and robust on a daily basis throughout the year, rather than only being available during the 2-3 week quarterly roll period. The growth in adoption for these solutions is coming from traders across the full spectrum of client types (banks, non-bank liquidity providers, corporates, hedge funds, and asset managers) – with key drivers being the separation of liquidity from credit, transparency and certainty within a firm, the fact it’s a Iit CLOB, and the efficiencies of clearing for margin, capital, and operational processing. We believe there is huge evolution still to unfold in the FX swaps market, and that the further electronification and automation of FX swaps is now possible using the firm, lit orderbooks for FX Link and spreads of FX futures.
Turning to NDFs, as markets evolve electronically and systems and processes become more robust, the overall environment becomes more fertile for increased volumes. Much like swaps, the higher interest rate environment increases the need for trading firms to hedge their risk, which creates renewed interest in NDFs and provides a growth opportunity for the instrument.
Back in 2019, we talked about UMR being a potential driver towards a cleared model for FX. Have you seen evidence of FX transitioning to a cleared environment since these rules rolled out? What are some of the benefits of moving more FX products into clearing, and what are the remaining barriers?
In 2022, we saw over $40 trillion notional cleared in FX products at CME Group, with over 90,000 unique traders involved in the marketplace. The large majority of this activity was in major, deliverable currency pairs – with the G7 pairs being the most actively traded and cleared. We believe the drivers for this use of cleared FX products, often as a complement to trading in the vibrant OTC market, is driven by a variety of catalysts, the most important of which depend on the individual customer involved.
The most common of these catalysts to consider for using our cleared FX products (be that forwards, NDFs, options or swaps) include access to a unique and complementary pool of liquidity, elimination of the need for ISDAs or bilateral credit lines, as well as credit and CSA agnostic pricing. Also important is that we have a highly diverse ecosystem of participants, with both active and passive trading supported – every client can aggress on the best price or can trade passively by placing one-sided interest into the orderbook. Further, the potential capital (GSIB and SA-CCR) and margin (UMR) efficiencies are also key motivations, as are the removal of counterparty credit risk against the LP, and the ability to trade peer-to-peer with a very wide range of LPs.
The next steps in the evolution of clearing are likely to be centred on product enhancements to make the process even more automated for customers. This will include the further automation of OTC-style trading into clearing via third-party vendors, and further granularity in our cleared FX products to provide more flexibility in matching cashflows on broken dates.
