As foreign exchange markets transition to a cleared environment, Janice Kan, Managing Director, Head of Markets, Equities, at SGX, talks to P&L’s Julie Ros about whether the developing opportunities and constraints represent a paradigm shift towards the futurisation of FX.
Julie Ros: Before we get into the detail, let’s take a brief look at the global FX market. It’s fair to say the past year has been a tumultuous one for currencies, especially given the US-China trade tensions. We have particularly seen growth in emerging markets trading, including APAC. Do you see a shift towards the futurisation of FX?
Janice Kan: The futurisation of FX is already happening in Asia and we can expect to see significant growth in this sector over the coming years. Singapore is Asia’s leading centre for currency trading and SGX is the largest operator of Asian currency futures.
For renminbi, we operate a very liquid FX futures venue to help mitigate currency risk via the USD/CNH futures that are actively traded by market participants (80% volume market share, 67% open interest share). Today we have a daily volume of around US$4 billion.
Access to credit remains a challenge in FX and we hope to extend this platform to introduce more non-linear derivatives and assist the market in participating in renminbi markets.
When SGX launched FX futures almost six years ago, most of the Asian non-deliverable forwards (NDF) traded were done through voice trading. While electronic currency trading was around, it was not nearly as prevalent as it is today. Also, trading Asian NDFs has always been opaque and costly. Over the last few years, the market has turned to SGX futures as it offers a more transparent order book, is fair, and also relatively inexpensive to trade. The cost of trading over-the-counter (OTC) FX is getting more prohibitive and exchange-traded FX provides a natural way forward.
JR: Post-financial crisis, when swap execution facilities (SEFs) were being developed for the expected arrival of mandatory clearing, there was a regulatory incentive to move FX into cleared models – and NDFs indeed went that way – but that mandate never came. Is there an economic incentive today to move more FX products into clearing?
JK: Today, capital savings is still the main driver behind these movements. The direction of travel is clear, particularly in Asia where standardised NDFs have gone the futurised way. Futures is superiour in the sense that it offers both a transparent price formation and a cleared solution.
However, not all FX products can be cleared, for example exotics. Clearing houses must understand the product risk and be adequately capitalised to clear and give market protection in the event of member default. OTC and futures are likely to co-exist and complement each other.
With new regulations coming into force (like Basel III), the cost of trading OTC FX is increasing (higher margin requirements). In addition, Mifid 2 and UMR are adding to OTC trading friction. A more flexible solution could take advantage of the more efficient futures contracts available on an exchange like SGX.
We introduced an innovative FX solution to the market and in the first quarter of 2019 went live with a pilot. We call this, FlexC FX.
SGX FlexC FX Futures offer market participants the ability to trade customisable FX futures in an OTC manner that clear the trades on SGX’s platform. It gives clients flexibility to choose expiry dates (like in OTC trading), take advantage of the efficiencies and surety of SGX’s CCP clearing house. All with the improved price discovery and risk management workflow.
With FX markets moving towards central clearing, this solution will offer a more effective way of enhancing operational efficiencies, lowering costs and counterparty credit risk, while keeping bilateral trading relationships. We have pivoted from NDF clearing to FlexC trading.
JR: What impact will Uncleared Margin Rules (UMR) have on the buy side, and what is a realistic timeframe for actually seeing these impacts? Are the UMR an easier proposition for larger firms, than the smaller firms?
JK: The delay of UMR to September 2021 for Phase 5 of the implementation is not ideal, but it also provides opportunities. It is a reminder to participants that this is coming and gives them time to get prepared. For some buy side participants that are not currently covered under UMR, this has given them the opportunity (and time) to assess alternatives to bilateral posting of collaterals. This involves clearing OTC FX trades, or potentially consider SGX’s FlexC FX Futures.
JR: FX options and NDFs represent only a fraction of the FX market. Is the next step to start clearing forwards, and how will the industry take this next step? Will we see the FCM model become more prevalent for FX market participants?
JK: Asian NDFs tend to be more standardised and hence can be traded and cleared as futures. FlexC will provide more flexibility for clients looking for broken dates (customised settlement dates). FCMs’ back office systems needs to be ready to support that.
JR: There has been some notable M&A activity with futures exchanges buying OTC platforms. Is there a case to be made that it will be more operationally and economically efficient for firms to clear their trades within the same silo that they execute in? Do such acquisitions of platforms that are providers of data, some of which offer analytical tools and other services, mean they can create a more bundled pricing structure for clients? Do these platforms/exchanges then have an advantage over purely OTC platforms?
JK: SGX recently made a strategic investment in BidFX, a specialised trading platform for global FX markets, in line with our strategy to build pillars of growth across multiple asset classes. With this investment, we have an opportunity to offer our suite of Asian FX futures alongside OTC products offered on the BidFX platform, bringing together both pools of liquidity, which further facilitates price discovery and opportunities for clients to cross-sell. Technical integration is completed and we are now focusing on going to market in the second quarter.
Since the exchange introduced FX futures in November 2013, over US$2 trillion in aggregate notional has been traded across its entire FX franchise.