Time for a new market structure

Research from client strategy firm, ClientKnowledge, shows prime-brokered volumes account for 30% of daily client turnover and 250,000-300,000 tickets a day. FXPB volumes have grown 50% per year, much faster than the rest of the FX market, not least because of the credit mitigation benefits CLS has brought.

The higher ticket volumes have spurred discussions on pre-settlement netting between banks to reduce the back-office capacity constraints being felt by some prime brokers. The problem there is that industry settlement system CLS is currently not accepting netted trades, so trades that are netted would have to be settled bilaterally, thereby re-introducing settlement risk.

But a paper released today by ClientKnowledge is calling for more radical, innovative solutions to deal with the pace of volume increase in vanilla markets and innovation in more complex ones.

ClientKnowledge says more automation of existing manual processes and the shifting offshore of more manual processes are no doubt part of the answer. But order of magnitude increases in efficiency and reduction in cost will have to come from a fundamental redesign of the processes themselves.

The company is bringing back the debate over the future market model for FX. It says the solution lies in a new structure with many of the benefits of an exchange but, perhaps, without the weightiness - a central credit matching, facilitating netting and clearing interchange.

"If the OTC markets are to move much further towards the levels of efficiency and scalability exchanges can offer, it seems to us they will also need to move more towards a central credit-netting, facilitation and clearing model for settlement," said David Poole, principal at ClientKnowledge.

He said this will function much like a central internet router or telephone interchange for the matching and clearing of credit and, therefore, resemble in effect but not in form a central counterparty exchange. "This will allow a step-change in simplifying and eliminating processes and fit with the trading needs of many market participants," he said.

With the typical cost per ticket for simple spot FX under $5 and more complex products like interest rate swaps, CDS and equity derivatives over $200 per ticket, the concept should make for some rousing debate at tomorrow's FX Week Europe congress in London. saima.farooqi@incisivemedia.com

Saima Farooqi, Editor