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Written by Laura Matthews
NEW YORK (Reuters) – Foreign exchange investors are moving more of their OTC derivatives into similar products on exchanges to avoid rising costs due to recent global regulations, helping to inject transparency into a multibillion-dollar market. It is largely hidden from the public eye.
The increased interest in clearing trades through the exchange comes as regulations attract more users of these contracts, reinforcing the need to move away from binary trading and manage the rising cost of compliance.
“There is more transparency and generally lower margin requirements (in trading listed products), which is beneficial for asset managers and hedge funds in leveraging their positions,” said Ben Fiore, head of forex trading and head of sales at Societe Generale. OTC 🙂 in New York.
Joe Meadmore, chief commercial officer at OpenGamma, a derivatives analytics firm, said the gradual behavioral change in forex derivatives trading is a result of increased margin and collateral costs.
From September 2022, buy-side companies with uncollected OTC derivatives totaling at least $8 billion are subject to regulations — set by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions — and must ensure sufficient margin to cover the risk of default by counterparty to the transaction.
OTC derivatives are privately negotiated contracts while clearing derivatives, though bilaterally negotiated, are booked with a clearinghouse such as a listed exchange. New margin rules exclude cleared trades.
Higher interest rates make rollover margin more expensive.
“A lot of stock exchange salespeople have been coming out to investors for a long time saying ‘look at how efficient the listed futures are trading,’ but it didn’t matter until now when interest rates are 5% instead of zero,” he said. Michael Riddell, CEO of Eris Innovations which is partnering with CME Group (NASDAQ:) and other exchanges to develop futures and options products.
The shift is most acute for buy-side companies that have to book margin for the first time, said Paul Houston, head of foreign exchange markets at CME Group.
“They will also bear the operational, legal and custody costs of establishing the margin facility as well as the capital costs of margin migration,” Houston said.
The CME futures and options market now trades at an average daily volume of $85 billion versus $76 billion in 2021, indicating that more investors are using exchange-traded derivatives to replace over-the-counter trades where possible.
This is still just a fraction of the $7.5 trillion that is traded daily in the foreign exchange markets, the vast majority of which occurs over the counter.
UK clearing house LCH’s ForexClear also set a record in May for FX options, passing $200 billion in nominal terms, meaning the total value of derivatives trading, for the first time.
“On the buy side, forex clearing substantially reduces counterparty risk, enables portfolio optimization and provides operational benefits,” said James Pearson, President of ForexClear.
Growing acceptance
About 60 companies have begun trading forex futures and options in the CME Group for the first time this year, more than two-thirds of which are buy-side clients, according to Chicago Mercantile Exchange data. Last year, 300 companies were trading in new instruments for the first time.
According to the ISDA, approximately 775 companies fell within the scope of the new rules last September.
Some clients of Record Financial Group, a currency and asset management firm, were exploring listed alternatives, said Tom Arnold, the firm’s head of sales, while others were adjusting their risk management software to “stay within or below the regulatory limit.”
Joe Spiro, director of product management at Hazeltree, said that as the company gets more exposure, it may have to comply with the new rules, which broadens the appeal of trading on exchanges.
Investors can now also transact on a relationship basis as they would in the OTC space and access clearinghouses.
For example, about 274,000 contracts in privately negotiated blocks and exchanges of related positions (EFRPs), products that allow users to trade based on an advertised relationship against liquidity providers and clearing access, traded on the Chicago Mercantile Exchange on March 8. , up 23% from the previous record set in December.
Customer clearance of non-deliverable futures contracts at ForexClear in the January-May period was $261 billion, up 58% from the corresponding period in 2022.
Not everyone sees the need to shift even as costs have risen and not all derivative products have a clear alternative, which limits wider adoption.
Peter Vassallo, portfolio manager for the currency team at BNP Paribas (OTC:) Asset Management, said that exchange-traded futures have a fixed settlement date relative to OTC futures, which makes them unattractive to some investors.
There are also concerns that pushing more trades into the clearinghouse will enhance rather than reduce risk.
“There are risks inherent in a lot of people who deal derivatives with one another,” Riedel said. “And no model removes all of these risks, it just shifts the place, but it can mitigate it.”