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The Best of Both: Combining OTC and FX Futures Markets

Paul Houston, executive director, global head of FX at CME Group, talks about practical applications of the exchange’s new FX Link product.

Explaining the genesis of the CME FX Link, which was launched earlier this year, Houston says that two years ago the exchange group was looking for ways to attract more people to its marketplace while also increasing the accessibility of its FX futures. A number of different ideas to achieve this were toyed with – such as creating new, shorter-dated contracts – but ultimately, staff at the CME concluded that it would be best to leverage the exchange’s existing liquidity pool.

As a result, FX Link was created, which essentially offers basis spreads between the OTC FX spot market and the first three monthly expiries on CME’s FX futures contracts and is traded via the Globex platform.

While stressing that this is a generalisation, Houston highlights two applications of this product that can benefit FX market participants.

“One is to enhance accessibility of our futures,” he says. “Traditionally, quarterly futures are traded as an outright and they’re often traded as a proxy to spot and so the participant who trades quarterly futures have on the other side OTC exposure, so FX Link is a way to manage those exposures and move between both markets fluidly. If it’s priced properly you can simultaneously buy and sell in one market, sell and buy in the other and manage exposures like settlement exposure and margin exposure and credit exposures across both marketplaces.”

Houston points out that a firm trading FX today typically has an FCM relationship on the futures side and a prime brokerage (PB) relationship on the OTC side of the trading business. What FX Link does is optimise between both marketplaces, enabling market participants that want to use the firm liquidity in the regulated marketplace of the CME to trade this product as a proxy to spot FX, while simultaneously allowing them to avoid holding the quarterly future to delivery because they can change their exposures back into OTC spot.

The second application of FX Link is to provide a central limit order book (CLOB), or alternative liquidity pool, for trading FX swaps and forwards, says Houston.

He continues: “So FX Link is a simultaneous buy and sell of OTC and then it’s like a  synthetic swap into a future date, so a monthly future or a quarterly future. We can see from our validation the buy side still like to retain their spot liquidity, but they’re using FX Link to roll on a CLOB that liquidity into a forward point, rather than captively with their spot provider, and get best execution or get a centralised trading venue to trade their FX swap. Similarly, we see spread traders, both banks and nonbanks, using the product to trade FX swaps for the first time, moving OTC exposures into monthlies. We did launch monthlies before FX Link, but monthly futures aligned with our quarterly futures offer a strip of forward curve in our FX futures for the first time and we’re looking to encourage spread trading FX futures outside of the quarterly roll.”

In this interview, Houston also discusses how new capital requirements and credit constraints are shaping and changing the behaviour of FX market participants.

The full video can be viewed here:

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Galen Stops

Galen Stops