Smaller funds dead set on futures

While forwards prices are showing signs of recovering from levels seen earlier this year, smaller funds say exchange-traded products still provide the best bang for their buck.

If they haven't already, a growing number of small fund managers are strongly considering switching out of forwards and into exchange-traded products to access the market for hedging and speculative purposes. One London-based fund manager that abandoned forwards trading in favour of futures contracts earlier this year said that, while the pricing of forwards might have improved, it's not enough to warrant a return back to that market.

"The futures liquidity is more than sufficient for smaller fund managers like me and the additional advantage is that you might not need foreign exchange prime brokers to trade futures," he said. "We also appreciate the transparency of markets such as the CME, as opposed to the lack of transparency in the over-the-counter market."

Others agreed that, after the sharp rises in collateral demands by dealers, the risks associated with forwards trading make the proposition unattractive. "The banks said, ‘Look we have to [raise collateral] because currency volatility has gone up and we need to provision for that'. That's fair enough, but the major ramification - of which there are many - is that the counterparty risk suddenly goes up a lot. Not for the bank but for the buy side, because the counterparty risk of using a particular bank means you can be held hostage like this overnight. You can be told, ‘By the way, next week we're going to need X amount of collateral more than what you are used to'," said another fund manager.

"The principal thing is to try to move away from OTC, where you are subject to all sorts of credit lines, all sorts of collateral requirements and, most importantly, bid/offer spreads. If you go on exchange you solve all three of these issues straight away," he added.

This might go some way towards explaining why volumes on the CME haven't experienced as sharp a decline as spot-only platforms. That, and perhaps the ability for traders to access multiple asset classes from the same platform.

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