Chris Soriano, executive director, head of cash emerging markets, Americas at EBS, will be speaking at the Profit & Loss Latin America event in Mexico City on March 25. Ahead of the event, he discusses the key opportunities and challenges facing firms trading NDFs, both in LatAm and globally.
Profit & Loss: What do you view as the key drivers pushing more NDF trading towards electronic platforms?
Chris Soriano: It’s a reasonable conclusion to make that all markets strive for efficiencies and e-trading is generally a more efficient way to trade liquid, commoditised instruments. The NDF market is somewhat a hybrid, divided between very liquid and more illiquid instruments and tenors. Not all instruments are suitable for a CLOB, so the key is deciding what the right trading vehicle or modality is for a specific instrument.
I would suspect the main contributor to the NDF evolution is the current market volatility dynamics. However, I don’t believe that the drivers for e-NDFs are any different than the drivers for other products. The key elements are client demand, having a central pool of liquidity to hedge risk and the need for reliable market data.
Finally, as we know, regulators are encouraging more transparent electronic markets because of their ability to produce both pre– and post–trade data to help to satisfy this requirement.
P&L: Conversely, what are the remaining barriers that are preventing, or at least slowing, more NDF trading shifting onto e-trading venues?
CS: There are a broad range of NDF pairs and, unlike spot G10 currencies, each pair has unique characteristics.
For example, some NDF pairs represent countries with active futures markets; these exchanges provide an additional avenue for institutions to exchange risk as well as provide an electronic data point to price off. The way that onshore spot markets operate also plays a role. Some countries have onshore electronic platforms to support their markets, while others may be more voice driven.
While not a hard rule, it’s a reasonable factor as to whether a specific NDF may have wider electronic appeal. To that end, it’s worth mentioning that in less liquid instruments, participants find it challenging to derive reliable and robust market data to manage that risk and to price customers. As markets mature in these pairs and liquidity increases, this becomes less of a problem.
P&L: Are there any lessons from the spot FX side of the business that are applicable to building out the NDF offering?
CS: In short yes. The roadmap is in front of us and provides both opportunities and lessons learned. The big difference is that as the spot FX market has evolved, much of what was experienced was relatively new to the IDB space. The spot market’s evolution has been impacted by several factors over the past 15 years, including fragmentation, aggregation and internalisation. That said, it’s important to understand that NDFs, while increasingly popular, are still a relatively niche market.
According to the BIS, spot G10 is estimated at $2 trillion per day in terms of average daily volume, while the total NDF market is $258 billion across all various tenors and pairs. That dynamic alone will make fragmentation more difficult and less beneficial. While in spot G10 it may be relatively straightforward to provide liquidity across a number of venues even if the underlying market liquidity may not support that, in NDFs managing risk across multiple venues may be more challenging.
It’s also worth mentioning the opportunities that market data brings, as well as the challenges it can present for execution. In spot FX, increased transparency was a key driver in bifurcating liquidity onto other venues like dark books and bilateral relationships as participants worked to mitigate market impact on the primary market.
Whether this bifurcation or the creation of regurgitated and/or “phantom liquidity” has been a net benefit to the market is up for debate. Either way, this newly created data has been an important factor and has spurred other industry topics, such as last look. As a service provider, our goal is to provide solutions to our clients that allow them to most efficiently execute their business while maintaining a fair and orderly marketplace.
P&L: When it comes to building NDF liquidity on your platform, are there challenges that are specific to each geography (or, put another way, is the business challenge different in Mexico compared to Singapore)?
CS: There are certainly geographical differences: some are regional, and some may be more country specific. The first thing to understand about the NDF market is that some pairs trade very centric to the region to which they are based. For example, LatAm NDFs are predominantly traded during the North American trading day and rarely trade outside of those hours. Asia, on the other hand, is much more global in nature. Less developed NDF pairs, like African or Arabic are much more bespoke and would operate primarily during the European trading day.
Zooming in a bit more, what we have seen is that counterparties trade NDFs predominantly out of regionally centralised locations. To put it into perspective, a large global bank may trade JPY out of multiple centres in Asia, however, most likely will trade NDFs out of only one. Finally, it’s worth mentioning that with few exceptions, NDF trading is not permitted in the host countries.
P&L: Why do you see an opportunity for more NDF e-trading in Mexico?
CS: Mexico for obvious reasons has ties to South American markets, and as we know Mexico’s currency is deliverable. As mentioned, NDF trading tends to be regionally centralised, so while local banks in Mexico may have a need to execute in certain NDF pairs I’m not sure widespread trading in NDFs is a necessity at this time.
Want to learn more about the latest developments in the NDF markets and how they might impact your business?
Soriano will be joined by an all-star line-up including Jose Cervantes, head of derivatives at Banca Mifel; Guillermo Camou, director, listed derivatives at Scotiabank; and Jason Woerz, president of 24 Exchange, speaking on the panel ‘What Next in the Evolution of NDF Trading?’ at the Profit & Loss Latin America event on March 25 in Mexico City.