Something that has bemused me a little over the past couple of years is platforms’ desire to throw plenty of resources at the NDF market – it ranks up there in mystification levels with why the authorities insisted on mandatory clearing for such a relatively low-key product.
I am not quite sure why I think this way – after all in the BIS Turnover Survey last year NDF trading was a serious contributor to growth (although it is interesting that since 2017-18 the regional surveys have offered a flatter growth trajectory), maybe I suspect that customers are less open to changing how they trade these products?
Two panels at our virtual Forex Network Chicago highlighted my point, when talking the electronification of FX swaps and options, neither was tearing up trees and growing to any marked degree. This is, I believe, partly because the market structure doesn’t exist, although 360T and Digital Vega have something to say about that and are seeking to provide just such a framework, but it’s also because the products have different characteristics. Swaps are very much about funding, options very much about hedging risks – neither are primarily used by the buy side to generate alpha.
With FX swaps, if banks are pricing smartly by showing their axe to the client then certainly up to one month, and probably three, many customers are getting close to choice pricing. In FX options there is a liquidity issue – conditions have not been great in options markets these past six months and conditions like that, where LPs can suddenly disappear, sees customers prefer to trade “visibly”.
I see NDF markets very much in the second bucket and that is maybe why I am bemused by platforms seeking to prioritise trading infrastructure in the product. Liquidity can be tight in NDF markets, take your data analysis of choice (and there are a lot out there now) and they all say the same thing – liquidity has recovered in G10 but is still patchy in emerging markets. Again, such conditions seem to push clients to maintain relationships – and that means shunning anonymous, CLOB, venues.
So why does a platform spend so much on delivering NDF trading? Well it could be it’s the only gap in the product range, but that is hardly the case with most multi-dealer platforms – and, again, wouldn’t swaps offer a better path? Equally, as is the case with someone like 24Exchange, it is the entry card to the FX market. The connectivity needs to be put in place anyway so why not pick a slightly esoteric product with which to kick off? This is fine, but again, I feel a platform has to deliver more than just NDF trading if it is to succeed.
When looking at the inter-dealer space, launching such a platform, as CboeFX did this week with the low-key launch of the rather strangely named Cboe Swiss (me neither), looks like an attempt to reinvent the wheel. EBS may have had its critics in the past over how it handled its spot franchise, but few, if any, user complaints exist about the NDF franchise, which operates slightly differently and, indeed, is looking increasingly like the model the platform will use for its G10 franchise going forward. Yes, there are those LPs on the outside who would love to get a bigger crack at this market but generally speaking, because of the sparse but improving nature of the data, and market conditions generally, most users are content with how it works.
And there, in a nutshell, is my issue with attempts to fragment the NDF market. This market learnt a lot of lessons from the evolution of spot world and avoided making the same mistakes (and yes, I know not everyone considers the FX spot market structure to be imperfect!) and that means that participants are largely content. Liquidity is robust but thin, pricing is consistent but not ultra-tight which means most people can get a deal done, at a reasonable price, when they want it doing.
That is what a successful market looks like and that is why I think new entrants will struggle – for if there is one thing we have learnt over the past decade in FX markets it is that attempts to reinvent the wheel have only succeeded in confusing people whilst failing to move the needle of innovation one jot.