Best exchange for FX: CME

 

FX trading activity on CME’s listed exchange has seen a significant uptick over the past 12 months, with open interest across many instruments now standing at record or near-record levels. While the continued rise in volatility in FX markets is partly responsible for the surge in trading activity for listed products, increased participation from market participants on the exchange – and particularly the buy side – has contributed to the bulk of the growth.

“It’s buy-side participation in particular where we’ve seen a lot of growth,” says Paul Houston, head of FX at CME Group. “We’ve had record participation from asset managers, hedge funds and other buy-side participants in our marketplace.”

While the overall FX futures volume on CME grew 26% year-on-year in June 2022 to an average of $97 billion per day, open interest across futures and options continues to break records. “We’ve had six open interest all-time records this year, including a record number of holders of large open positions,” explains Houston. “We’ve seen asset manager positions grow by 60% since the second quarter of 2020, with the buy side holding nearly 60% of the open positioning in EUR/USD, for example. We’re very pleased about the growth in buy-side participation and the growth in our marketplace overall.”

For Houston, this demonstrates that participants are seeing the general benefits of trading and clearing FX via CME. Some value the reduced operational costs associated with trading on an exchange, appreciating that facing one central counterparty allows them to standardise processes and operations. This is largely due to there being only one set of legal documents to be managed compared with the multiple International Swaps and Derivatives Association contracts and credit support annexes needed to enter over-the-counter (OTC) FX derivatives transactions. That, says Houston, appeals to a lot of buy-side participants, particularly those that trade FX as a hedge.

Others on the buy side are looking to CME’s cleared FX futures, swaps and options to manage their exposure to uncleared margin rules (UMR). It is estimated that between 800 and 1,000 firms will need to begin posting margin on certain FX products when the threshold for inclusion drops to $8 billion for those based in the US or €8 billion for those headquartered in Europe under the final phase of UMR in September 2022. CME’s cleared FX products do not contribute toward the UMR threshold so, for those firms with large holdings of in-scope instruments – namely uncleared OTC FX forwards, swaps and options – switching to these on-exchange instruments can ensure they stay below the trigger levels.

For those that cannot avoid staying below the UMR threshold, Houston notes they can nevertheless make substantial margin cost savings north of 80% if they opt for cleared FX on CME, particularly in FX options.

“We’ve made a lot of changes to our FX options products over the past three to four years to become a better proxy to OTC,” he explains. “We’ve aligned expiry times, added more maturities and have made our strike listings more granular. As a result, many market participants are now using CME FX options as a natural complement to their OTC activity, with volumes up 25% versus the same time last year.”

Another popular feature among market-makers is the ability to trade FX futures as a proxy for FX swaps via CME’s FX Link, in which market participants trade the spread between OTC spot and a CME-listed future. Market-makers can use FX Link to move inventory between markets to optimise their capital exposure, while others have even begun using FX Link as a central limit order book for swaps.

CME has invested heavily in creating an ecosystem that not only reinforces the benefits of an exchange model but also brings OTC-like features into a listed environment. This is demonstrated in the growth of off-exchange trading in blocks and exchange for physical transactions – both of which are trades that are privately negotiated on a disclosed bilateral basis and then subsequently submitted to the CME – a solution that has become increasingly popular with the buy side.

Asset managers and hedge funds appreciate the ability to trade large futures and options transactions at one risk transfer price with their chosen liquidity provider, just as they would in the OTC market, while also gaining the benefits of centrally cleared FX. Blocks of futures can also be traded with more granularity – down to one-tenth of a pip – than normal futures transactions, and reporting times have been extended to ease adoption.

“We see block trading as a very good complement to our electronic marketplace in both futures and options,” says Houston. “Blocks provide market participants with the best of both worlds – they can get OTC-style execution by trading directly with their chosen bank or liquidity provider, but then benefit from clearing the trades with CME.”

CME was voted Best exchange for FX at the FX Markets e-FX Awards 2022.

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