Is this FX futures’ big moment?

Exchanges eye big opportunity for their FX futures offerings as initial margin deadline looms

From September, around 200 large buy-side firms will have to start posting initial margin on their non-cleared derivatives, including foreign exchange options and non-deliverable forwards.

While the looming deadline might fill many with dread, not so at CME and Eurex, which spy a big opportunity for their FX futures offerings

For the past year, they’ve talked up the potential of the deadline as a key tipping point for the product, particularly as an alternative to FX swaps. While FX swaps are exempt from initial margin under the rules, the idea is that if a firm’s other bilateral products are going to be subject to the requirement, they might throw swaps into the same pot.

Through their offerings of exchange-for-physical (EFP) services, which see a spot and futures contract traded simultaneously in the same way a spot and forward contract would make up an FX swap, the exchanges hope that if they’re posting initial margin anyway, buy-side firms might see the benefit of using a clearing house instead. 

The benefits are clear – multilateral netting, operational efficiency, and lower capital charges for dealers.

The exchanges have also tried to introduce new products to give users the option of trading blocks in a disclosed environment, and new products that roll daily, or that give flexibility on expiries. You can’t say they aren’t trying.

But inertia is a strong force, and the history of financial markets is littered with projects that worked great in theory but never gained traction. For example, it makes perfect sense for the buy side to trade standardised interest rate swaps on an all-to-all central limit order book to cut out the dealers, but despite post-crisis rule changes encouraging the move, execution has stubbornly remained on a request-for-quote basis.

Part of the issue is the cost and effort needed by the buy side to get set up for trading a new product and connecting to a clearing house – commodities that are always in short supply, but particularly so given they must compete with other projects like the incoming initial margin rules and Libor transition. Given how easy and liquid bilateral FX swaps are to trade at present, to some it’s not worth the effort.

It’s also hard to know exactly how much demand is currently out there for futures. Dealers talk about the potential of FX futures, but say clients aren’t exactly knocking down their door asking to trade them. And at around 2% of global FX daily turnover, according the Bank for International Settlements, futures have a long way to go before the size of the liquidity pool becomes an attracting force in its own right.

But looking at the exchange volumes in futures, particularly in EFP trading, there’s no doubt that interest is growing. So, all eyes will be on the volume statistics over the next few months to see whether September will truly prove to be the turning point the futures market has been looking for. 

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