Unlocking the electronic potential of FX swaps

The electronic evolution of FX swaps may lag other instruments in the FX market, but the opportunities for these widely traded instruments are considerable

The FX market has long been a pioneer in the digital transformation of financial markets, with instruments such as spot and non-deliverable forwards (NDFs) leading the charge towards electronification. Yet, despite being the most traded instrument in the FX market, with $4 trillion traded daily, FX swaps remain less electronically traded than spot, with a significant proportion of activity still executed via voice channels.

While the latest Bank for International Settlements triennial survey reports that 56% of FX swaps are traded electronically and that this share had not substantially changed since its previous survey, the opportunities and benefits of shifting towards further electronification are considerable for an instrument that plays such a critical role in the FX market.

Indeed, FX swaps are the corner-stone of currency hedging. And, in a world marked by geopolitical and economic uncertainty and frequent bouts of volatility, efficient hedging is an economic imperative for many market participants.

Corporates and asset managers have had access to electronic FX swap prices from their banks for more than 20 years. The problem lies further up the chain. In spot, market-makers price their clients and then hedge that risk in deep electronic liquidity pools. In FX swaps, these pools are much shallower, which makes hedging harder for dealers and leaves the buy side largely restricted to taking prices without a way to be a passive participant.

Deeper electronic liquidity would help dealers hedge more efficiently and price more tightly, and could eventually give corporates, asset managers and smaller financial firms more direct access to the market.

Some participants already trade FX swaps electronically wherever they can.

“Electronically traded FX swaps are central to the way we operate on a day-to-day basis,” explains a senior trader at a US FX volatility hedge fund. “We trade FX volatility with options, and a by-product of trading those options is that we are left with deltas that we need to hedge. At the end of every day, we need to have only a dollar balance on our books, so we use FX swaps to roll those cashflows.”

“We have a fairly large book – in the order of 20–25 currency pairs – and for our middle office to roll every currency pair via voice would be pretty inefficient. By trading electronically and routing orders for all our currency pairs through a platform, everything is done automatically. It’s just more convenient for us to trade like that. Everything we can trade electronically, we’ll trade electronically.”

The hedge fund currently conducts 90% of its FX swaps hedging activities electronically.

“If we were to do all that manually, we’d need to call our broker for every swap and then book them manually, which is just very inefficient. And I don’t think the voice price would be greatly different to the e-price. It’d be negligible.”

Once the entire lifecycle of an instrument is electronified, it’s easier for people to trade. And, once it’s easier to trade, the velocity of turnover increases exponentially

Simon Jones, LSEG

Electronification enhances operational efficiency and reduces costs

One of the most compelling arguments for trading FX swaps electronically is greater operational efficiency and the potential to reduce operational costs. Electronic trading streamlines the entire lifecycle of FX swaps – from execution to settlement – thus reducing the need for manual intervention. And, with tighter spreads and reduced reliance on intermediaries, electronic trading may facilitate more competitive pricing and contribute to lower execution costs for market participants.

Application programming interfaces (APIs), which connect one application with another, are central to the automation of workflows, and their use not only lowers transaction costs but greatly facilitates the allocation of credit.

Simon Jones, head of FX product and liquidity at LSEG, highlights the great strides liquidity providers of FX swaps have made in recent years in the electronic allocation of credit. He explains that credible solutions have been brought to market to address the counterparty credit risk of future exposures that are inherent to FX swaps trading.

As trading venues adapt to accommodate the myriad ways banks manage credit – whether manually, via APIs, through credit files or confirmation requests at the point of trade – Jones is optimistic that a greater proportion of the more than $1.6 trillion of FX swaps currently traded over voice daily will shift towards more electronic means in the near future.

“The direction of travel is certainly on the right track,” he says. “Once the entire lifecycle of an instrument is electronified, it’s easier for people to trade. And, once it’s easier to trade, the velocity of turnover increases exponentially.”

Chris Soutar, strategic lead – FX swaps at LSEG, believes the next phase of growth will come from broadening access to electronic liquidity and simplifying workflow complexity.

“The market has already demonstrated a clear appetite for electronic execution, particularly in shorter-dated FX swaps. The opportunity now is to extend those benefits across a wider range of tenors and currency pairs. As workflows become more automated and credit processes more streamlined, we expect more volume to migrate towards electronic channels, helping market participants access liquidity more efficiently and manage risk more effectively.”

Slashing longer tenor costs

Beyond operational efficiency, electronification also unlocks opportunities in other areas, such as reducing the cost of trading longer tenors. Currently, FX swaps are predominantly traded on the short end of the curve – up to seven days. However, electronic trading can contribute to more competitive spreads for longer-dated FX swaps, making them a more accessible hedging tool to a wider range of market participants, particularly corporates and asset managers.

Venues are also cutting costs directly. In May, LSEG FX removed brokerage fees on FX swaps of one month and longer on its FX Matching platform, reducing the applicable brokerage charge for taking liquidity at those tenors to zero – a benefit that already applied to placing orders. The firm believes that removing cost as a hurdle in those tenors will progress an ecosystem that, once established, will bring wider benefits to the buy side as well as the sell side. Banks, for example, would be in a position to offer FX swap algos to buy-side clients with large swaps to execute.

FX Matching has been a trusted source of price data for the interbank spot market for decades. We want to do the same for swaps – across the whole curve

Chris Soutar, LSEG

Improved transparency

Electronification brings greater transparency, enabling participants to make informed decisions and manage risk more effectively. Electronic platforms provide instant access to pricing, liquidity and market depth, empowering market participants with the information they need to execute strategically.

The greater electronification of FX swaps is not only making the instrument more accessible and efficient for a broader range of market participants, but it also sets the stage for further developments in the market, such as artificial intelligence-driven workflows.

“FX has often been at the forefront of electronification as it has several properties close to that of the perfect market,” says Marcus Fernandes, global head of currency management at Northern Trust. As such, electronification brings with it access to a larger pool of data points that can be used to build a more accurate view of a market that remains – and will continue to remain – overwhelmingly over-the-counter.

“With the right model, market participants can use AI to build their own metrics using these data points, rather than being dependent on someone else – that’s the nature of the beast,” Fernandes says. “AI can help market participants collate large volumes of data, deal with it faster and build an independent view of the market. I think that’s how workflows are changing.”

“Electronification and AI bring with [them] optionality in terms of greater access to data, and the ability to evaluate ideas and push through greater transparency within the system.”

While the rate of adoption within the industry may vary, Fernandes is confident that the direction is clearly heading towards higher levels of electronification.

For LSEG, the quality of the underlying data is key. “The more that FX swaps trade on an order book, the better the price data that comes of it – and that data can support firms in developing their own analytics, AI tools and execution algos,” says Soutar. “FX Matching has been a trusted source of price data for the interbank spot market for decades. We want to do the same for swaps – across the whole curve.”

As the market continues to evolve, greater electronification is expected to play an increasingly important role in supporting a more efficient, accessible and dynamic FX swaps market.

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