Hong Kong Exchanges & Clearing (HKEX) becomes the latest major exchange group to identify FX clearing as a growth area, after announcing last week that its OTC Clear service handled its first deliverable FX swaps and forward contracts.
The banks involved in the transaction – which was hailed by HKEX as “a step forward in OTC Clear’s role as an offshore RMB clearing hub for Mainland China” – were Shanghai Pudong Development Bank (Hong Kong Branch) and BNP Paribas.
The exchange group has revealed that in total, FX clearing volumes surged 25% in Q3 compared to the same period last year, led by cross-currency swaps, which saw volumes increase by 30%.
HKEX actually launched clearing for cross-currency swaps three years ago, but as Jacky Mak, managing director, OTC & FIC business development post-trade at HKEX, explains, it has taken some time to educate market participants regarding the economic case for this service.
“When we first launched clearing for cross-currency swaps, it was a challenge because many people were unsure if these products need to be centrally cleared. But now as we have built out the interdealer market, firms are starting to see that there’s value in the service because it can help them save costs. As a result, we’ve attracted more members to the clearing service and volumes have increased,” he tells Profit & Loss.
Mak notes that it has taken hard work to educate market participants on the benefits of clearing OTC FX products more broadly because the value of the service for this asset class is not always immediately apparent upon first glance.
“Some people assume that because FX products, including cross-currency swaps, are not subject to bilateral margin requirements that it doesn’t make sense to put them into a CCP, where they will be charged margin for clearing those products,” he says.
Mak continues: “If you just look at the margin on a single transaction that might be the case, but a lot of the time people under-estimate the power of the multilateral netting offered by a CCP, which can reduce bilateral margins as well as a lot of their notional exposure.”
However, he stresses that there is no “magic equation” to determine whether clearing particular OTC FX products makes sense, because there are numerous factors internally within banks that need to be considered when evaluating the case for central clearing.
Another driver towards central clearing highlighted by Mak is that some banks are currently experiencing constraints around credit when it comes to facing off against counterparties for FX trading, something that central clearing could help alleviate.
“For the USD/CNH market in particular a lot of the liquidity is coming from Chinese banks, and they generally trade long-dated FX swaps or forwards instead of short-dated products, and this can also become a credit challenge,” said Mak.
Mak highlights another benefit of central clearing: when firms trade some long-dated products they can end up with an FX delta that could attract a very high initial margin from the CCP. But if they do short-dated FX forward trades, they can net this off against the FX delta to reduce and optimise this margin requirement.
“This illustrates how putting more products into FX clearing can help firms reduce their gross notional outstanding and optimise margin requirements,” says Mak.
Looking ahead, Mak says that HKEX will focus on developing clearing solutions on the client side. For example, an insurance firm in Hong Kong might receive insurance premiums in HKD from their customers, but then switch it to USD in order to invest in USD denominated assets. This would trigger the need for cross-currency swaps or FX swaps. Normally, such a transaction would eat up a lot of that firm’s credit limit and could be subject to margin requirements for non-centrally cleared swaps, but central clearing could be a solution for both of these problems.
“Right now we’ve been focused on the interdealer market, but I think that the next step for us is to develop solutions for the clients as well,” says Mak.
HKEX is not the only major exchange group looking to expand its OTC FX clearing capabilities at the moment – Profit & Loss recently reported that Eurex has begun clearing cross-currency swaps, while LCH, which is owned by the London Stock Exchange Group (LSEG) has added deliverable FX products to its ForexClear service.
Mak will be speaking on the panel session “Is it Time for a New Credit and Clearing Model?” at the Profit & Loss Hong Kong conference on November 7. To view the agenda or register for the event, which is free to attend for buy side and bank attendees based in Asia, click here.