FX Invest: Deeper markets, broader opportunities

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Is regulation spelling the end of foreign exchange as an asset class? Absolutely not. The ‘will they, won't they' debate on whether regulators will exempt foreign exchange swaps and forwards does pose some interesting questions. But by no means is the ability to generate returns from the forex markets as it stands today - without crashing the global financial system - in doubt.

The US Treasury agrees. In April, it proposed to use its discretion to exclude FX swaps and forwards from mandatory clearing under the Dodd-Frank Act. To ensure unison, on July 5, the European Parliament recognised that the characteristics of the FX market call for an “appropriate regime that would rely notably on preliminary international convergence and mutual recognition of the relevant infrastructure”.

There is a valid reason for their position – the predominant risk in FX is settlement risk, which has largely been dealt with through the extensive use of CLS Bank. In June, CLS settled on average $5.12 trillion a day, up 21% from $4.23 trillion in June last year.

Meanwhile, credit and liquidity risks are also effectively self-regulated through increased use of credit support annexes and credit valuation adjustments (CVA) across client segments. And four of the top FX prime brokers have teamed up with six of the most active trading platforms to introduce a kill switch, to cut off clients that exceed credit limits and pose systemic risks to the market.

What does all this mean for the FX investor? There are changes afoot. Forex options and non-deliverable forwards don’t seem to have been given a reprieve from requirements to be traded on exchange-like venues and mandated central clearing. This has implications for the way collateral works (see ‘Implications for collateralisation under new CCP model’) and indeed how markets themselves can be accessed (see 'Rise of the super-Sefs'), in the new world. 

Similarly, a growing number of products are emerging in the market to take advantage of the high levels of volatility and the seemingly endless supply of event risks (see ‘New indexes trade volatility’). And then there are the emerging markets. Despite the liquidity trap that was the 2008 crisis, with $4 trillion traded a day in FX, it does represent the most liquid asset class giving opportunities to take advantage of any market conditions (see ‘Overlay Asset Management sticks with emerging markets’). The platforms reflect this deep liquidity, with volumes traded on Icap’s EBS platform up 17% to $174.1 billion in June.

So what are you waiting for?

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More articles from this issue

US margin proposals could lock down $2 trillion in assets

Volatility trading comes up trumps in June

Buy-side cautions on collateral

EIB signs Citi for collateral management

US dollar's time as world's reserve currency draws to a close

Macroeconomic uncertainty boosts demand for gold and oil exposure