THETRADETECHFX DAILY from the floor
Patrick Forde , head of trading , Fulcrum Asset Management
The recent growth in the FX futures market is driven from two sides . Firstly , the benefits of holding a centrally cleared product vs an OTC FX trade . Secondly , recent changes made by the CME ( and other exchanges ) to allow futures participants access to wider OTC liquidity pools . Holding a future can have substantial benefits in terms of leverage / sum of notional calculations , margin requirements , counterparty risk , as well as operational efficiencies . Changes made to FX futures contracts in recent years have substantially reduced some of the liquidity barriers to trading FX futures , particularly in less liquid contracts outside G4 currencies . In the past , the only option was to trade on the exchanges Central Limit Order Book of the future directly , which limited sources of liquidity for larger trades . The CME have now introduced ‘ EFRP ’ ( Exchange for Physical ), so one can now agree an OTC FX trade and exchange that for a future once the OTC trade is done . This allows us to have the best of both worlds , in that one can access all available liquidity ( across the CME Order book , and the OTC market ), while holding a centrally cleared product . Many market makers / banks continue to look at FX futures as distinct products / separate risk to OTC FX . Historically , this made sense as these products were not fungible / interchangeable . Now that the CME allow exchange of an OTC FX trade into a future , market makers need to rethink this separation and come up with products that give buy-side participants flexibility to move between OTC and futures liquidity more easily . Most banks require a manual step to block or EFRP to FX options and futures , this makes pricing slow and cumbersome . We need solutions that automate this process in order to make it scalable and operationally safe . UMR has increased the cost of holding OTC FX positions for the buy-side and prime brokers . This makes the traditional FX model ( OTC and PB ) more expensive . Prime brokers are also finding their FX PB less profitable in this environment which ultimately makes it less attractive as a business for them . I expect this will lead to substantial changes in how the FX market is intermediated in the next three to five years . The two obvious alternatives to FX PB are FX futures or a centrally cleared OTC market like we have in interest rate swaps and credit . The centrally cleared OTC offering in FX is still very limited , mostly to non-deliverable forwards and lacks scale due to lack of uptake . This lack of scale ultimately makes it less diversified and more expensive at present . This leaves FX futures as the most attractive option , for now , to gain FX exposure in a scalable , cleared market . Building a knowledge base on how the FX futures market works and different ways to access various pools of liquidity is a key starting point . For some currencies / trade sizes it might be optimal to trade on the Central Limit Order Book of the exchange , while trading FX futures in less liquid currencies in large size , it is essential to understand how one can gain access to OTC liquidity , using EFRPs and Blocks to translate this into a future .
“ UMR has increased the cost of holding OTC FX positions for the buy-side and prime brokers . This makes the traditional FX model ( OTC and PB ) more expensive .”
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