A year in review for FX: volatility, regulatory milestones and capital efficiency

FX markets experienced volatility and regulatory milestones this year. Paul Houston, CME Group’s Global Head of FX Products, reflects on prominent trends faced by the industry in 2022, as well as what they will be confronted by next year

CME Group

As volatility has returned to FX this year, liquidity has become more of a premium to market participants.” Houston explains that “more and more OTC market participants have been turning to futures and options listed on all-to-all streaming electronic order book for both price discovery and differentiated liquidity in 2022.”

From a regulatory perspective, “the final phase of UMR in September was a key milestone for FX market structure, but it will take time for market participants to adapt. We have already seen that there are potentially significant margin savings to be made from trading centrally cleared listed FX options versus traditional uncleared OTC FX options for those impacted. The reopening of the annual AANA calculation window in March 2023 may act as a further catalyst for investment managers to alter their approach. FX futures are not included in the ANNA calculation, making them a useful complement to FX forwards without impacting the threshold.

In terms of market activity, “Year-on-year FX option block volumes have risen over 50% this year, with increased participation from the asset manager community who often crave the certainty of just getting a ‘large’ trade done at one granular price, instead of working an order or breaking a trade down into smaller multiple orders.” Where this leaves us in the year ahead, Houston anticipates that “while block trading is not always going to be the primary option for trading listed FX products, activity across 2022 shows that it is an additional workflow some asset managers want to use as a mechanism that closely matches their OTC behaviour heading into the New Year.”

Reflecting on CME’s business this year, Houston observes that “2022 has been a record year for new market participants and new liquidity across our $81 billion per day (ADV) listed FX futures and options market. In response to central bank rate decisions and in response to new regulatory changes as well as the enhancements made to our products, we have seen firms turn to listed FX instruments as alternatives to OTC products, leading to record levels of open interest. Increasing open interest represents new or additional positioning in the market – it peaked in June at ~$295.8B notional outstanding (3.19M contracts). The number of holders of large open positions, as defined by the CFTC, reached an all-time record of 1,312 in May, with much of the increase driven by buyside firms.”

A highlight of the year included how “in a year of increased volatility, more market participants across the industry have looked at the execution choice available on CME Group’s listed FX markets, whether through the differentiated liquidity available on the electronic CLOB or through privately negotiated CME FX futures and options transacted on a relationship basis. This choice offers greater accessibility to CME FX markets with the end result the same- a cleared FX Future or Option with the resultant efficiencies that brings.”

Houston goes on to say that “we’re particularly proud of the growth in privately negotiated trades that mirror the OTC market – via a growing network of Liquidity Providers, deals are priced, dated, and decided and then subsequently submitted and cleared in our market. There are now over 20 firms pricing blocks and EFRPs to banks, hedge funds, asset managers and corporates.”

Moving on to trends that will continue in 2023, Houston remarks how “in 2022 there has been an increased focus on regulatory change and the actual or potential increased costs of capital that may result. We still haven’t seen the full impact to customers from UMR Phase 6 and SA-CCR but many are looking at listed FX futures and options to manage their costs, either through a more efficient capital treatment or because netting and clearing against a single regulated central counterparty reduces exposures and hence costs considerably.”

He also thinks that “2023 will continue to see an emphasis from market participants to optimise capital more efficiently. In particular, regulations such as SA-CCR and UMR may serve as catalysts for market participants to seek complimentary ways to transact and manage their FX exposures. We have seen this trend emerge in 2022 and expect a continuation in 2023. Centrally cleared futures and options have long been recognised for their capital efficiencies, and our focus has been on enhancing the products to make them as cost effective and accessible as possible. We see execution choice as particularly important – market participants can access these efficiencies through relationship trading, blocks and EFRPs, as well as our highly liquid central limit order book.”

Paul Houston, Global Head of FX Products, CME Group
Paul Houston, Global Head of FX Products, CME Group

Paul Houston is CME Group’s Global Head of FX Products. Prior to CME, Paul has worked in FX and fixed income prime brokerage at Deutsche Bank, Credit Suisse, RBS and JP Morgan Chase.

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