March 25 marks the one year anniversary of the launch of CME’s FX Link, probably the most significant attempt by a market intermediary to establish a bridge between OTC and futures markets. In terms of volumes, as expected the growth has been steady rather than spectacular, although FX Link did hit a new record high on March 7 at just under $2.7 billion notional. Generally speaking the platform is handling average daily volumes in the region of $1-1.5 billion in 2019.
Paul Houston, global head of FX products at CME Group, expresses satisfaction at the progress made in the first year, but stresses there is more to come. “We have 25-30 market participants on FX Link, the majority non-bank liquidity providers using FX Link to manage exposures across spot and futures markets, but we are also starting to see growth from banks and users of our options products, in addition to growing buyside interest.,” he says. “The two main use cases are pretty much as we expected, we are seeing banks use FX Link to move OTC positions into futures to get the capital and credit benefits, and we are also seeing banks use FX Link as an e-FX swap – again because they receive the capital efficiency benefits.”
To Houston’s second point, automation of the FX swaps market remains patchy at best. Talk to banks and they speak of impressive e-ratio growth in FX swaps on their single dealer platforms; but when it comes to hedging out of the risk the voice channels are still thriving.
Most e-FX managers in banks acknowledge the benefit of greater automation, but it seems they are taking their time in coming around to the other benefits FX Link can offer. “We are having a lot of conversations with participants from all sides of the market and if that interest converts into connections to FX Link then we will see good growth,” observes Houston. “We are in the process of onboarding several more participants, but on bank FX swaps desks especially, they have not historically used futures so it takes time for the benefits of the model to be accepted and then adopted. There is also the fact that onboarding a new product – and FX Link is still a new product of course – can take some time.”
Last month CME launched USD/CHF and NZD/USD on FX Link and Houston says those products have been “going well”, he also hints that more currencies could be added at some stage. “We are getting a lot of enquiries about rolling out other liquid currency pairs such as CNH onto FX Link,” he says. “We may expand the product set going forward but we want to really focus on building volumes in the existing pairs.”
Aside from the obvious objective of increasing the number of participants using FX Link and, possibly, more currency pairs, Houston is also optimistic about the early signs of interest from the buy side. “We have buy side firms looking to synthetically roll their spot positions into a swap using FX Link,” he explains. “They see the benefits of being able to execute spot risk algorithmically and then roll the position electronically as well.
“Users of our FX options products also see the opportunity to roll their delta hedge trades using FX Link,” he adds. “There are really good use cases for FX Link, our job is to continue to raise awareness of the benefits and opportunities available.”
Although volumes have dipped from the start of the year, the good news for CME is that the overall trend remains positive with Q1 2019 activity still up measurably vs second half 2018.. Volatility, it is widely acknowledged is at historic lows in spot markets and the message from the Federal Reserve that it will be unlikely to move rates again this year puts as a further dampener on proceedings.
That said, however, this could be an opportunity for those banks toying with the idea of onboarding to FX Link to do so – if for no other reason that when returns are diminishing, every efficiency helps the bottom line. This means that ultimately, the catalyst for the next stage of growth in FX Link may be something as prosaic as people actually waking up to what remains a good idea.
Overall, the cautious optimism with which FX Link was launched is still very much the mood as far as Houston is concerned. “We are pleased with the first year, we have onboarded a good mix of participants, have seven prime brokerage firms connected and a good pipeline of new participants,” he says. “This interest is coming from the buy side, prop shops and major banks, but also from regional banks looking to shift their CCAR and GSIB risks onto FX Link.
“Looking ahead, we want to maintain and increase our volumes and I think that will come. We understand that the whole answer to the FX swaps market’s development does not lie in futures, but they do offer several benefits. FX Link is the bridge between OTC and futures that can deliver those benefits.”