FXPBs see compression tech as key for credit optimisation

Foreign exchange prime brokers (FXPBs) are increasingly harnessing technologies to clean up margin-intensive options portfolios and help them reallocate credit to their largest clients.

Compression and novation tools have become an effective way for FXPBs to reduce the notional footprint on their hedge fund clients’ FX options books, in response to the uncleared margin rules (UMR).

Novation, the practice of transferring the contract from one dealer counterparty to another, is commonly used for large interest rates swaps books where trades can be novated on the same day. However, for FX options, this has largely been a manual process, where novations can often take several weeks.

“With UMR and the cost of funding these covered products, especially FX options, the incentive is now very serious,” said Nathaniel Litwack, global head of FX prime brokerage at BNP Paribas, speaking at the FX Markets USA conference on October 17.

“If you are dealing with the largest multi-strategy, global macro hedge funds, they’re very sophisticated, they have large options books. You need to optimise, and you need technology to optimise. And you need the industry bought in – it’s a work in progress.”

Capitolis has a service to automate FX options novations across dealers and flatten risks, with many of the top FXPBs and hedge funds involved. According to the vendor, it has novated 81,000 trades and reduced total notionals by over $9 trillion.

With UMR and the cost of funding these covered products, especially FX options, the incentive is now very serious

Nathaniel Litwack, BNP Paribas

Most recently, the tech firm expanded the novation service for prime brokers handling agency FX options trades – flows from firms trading on behalf of underlying clients. This is a more complex workflow, as it requires maintaining anonymity throughout the entire process.

John O’Hara, head of America prime services product at Standard Chartered, said on the panel that the bank has used this service to deal with its large FX options books. However, he noted that the next challenge is getting the technology to replenish clients’ credit lines once their options portfolios are compressed.

“If you have a back office that's devoting man hours to replenishing utilisations across the firms you've done the novations and the compressions with, it's not an ideal solution. I think there's probably going to be a combination of technologies, where you can get that relief, the compression and tear-up of trades, but also get the utilisation back to levels that they can trade and build up again,” said O’Hara.

Another emerging technology vendor for FXPBs is CobaltFX. Its Dynamic Credit platform allows FXPBs to conduct pre-trade credit checks, view and manage limits more easily, and pull lines quickly if necessary. BNP Paribas and NatWest Markets have become the first two dealers to go live on the platform in order to get control of their credit limits on anonymous interbank venues.

William Egan, head of FX prime brokerage for the US and Asia Pacific at NatWest Markets, said the next aim is to combine these various technology solutions for optimising credit allocations.

“When you start to combine these work streams together, you can see what we're trying to get to as an industry. And I think that's where it begins to make sense, because clients are going to be happy because we're able to dynamically replenish lines and make sure we don’t have too big lines all over the street,” he said.