Its been my experience that many in the market are ignoring FX in the global derivatives reform debate, thinking of them as broadly exempt from new rules. This view is a bit of a red herring. Our latest research report digs into the regulations set to hit the FX derivatives market and the impact they will have on FX product selection.
Based on data gathered via over 1700 interviews with FX traders and portfolio managers and analysis of the regulatory landscape, our research finds a clear trend exists towards growing demand for FX futures in lieu of traditionally bilateral FX derivatives. The latter will continue the make up the majority of notional trading volume, but as the economics of those products change at the hand of new global regulations investors will start to look for cheaper alternatives. While the FX story has similar elements to the fixed income swap futures debate, the pro-futures argument is arguably even more compelling for FX. The report is available for all Greenwich customers, so please take a read and let us know what you think. The press release:
Stamford, CT USA — Changes brought on by new regulations will drive trading activity in foreign exchange away from options and non-deliverable forwards (NDFs) to futures, which will become a much bigger and more important part of the FX market. In a new report, The Futurization of FX Derivatives, Greenwich Associates says the movement of trading activity to futures will require investors to rethink how they access the FX market, dealers to revamp business models to facilitate trading in a profitable way, and technology providers to offer solutions to help all market participants adapt and succeed in the new market. “A conservative 5% move out of OTC FX derivatives into futures would cause FX futures volume to grow by over 50%—a huge boon for futures exchanges,” says Greenwich Associates principal Kevin McPartland, Head of Market Structure and Technology Advisory Service and author of the report.
Three Reasons for a FX Derivatives Victory
The report identifies three drivers of the coming shift of FX trading volumes to futures:
- While FX swaps and forwards received exemptions from trading and clearing requirements imposed on derivatives in other asset classes, they will still feel the impact of trade reporting requirements, anti-evasion authority, business conduct standards and Basel III capital requirements. These influences are likely to encourage a shift of some FX swaps and forwards business to futures.
- NDFs and FX options did not escape the grasp of trading and clearing requirements and the high margin rates they bring, setting the stage for their users to migrate some of their trading to futures as well. Once these rules set in, trading these products will become more expensive. Greenwich Associates data shows that the trend away from NDFs has already started. Whereas over half of investment firms used NDFs in 2010, at the end of 2012 only 35% used them, with hedge funds leading the pull back.
- Financial users of these products, which drive most of the volume, require less customization than corporate users, making it likely that they will migrate some of their flow to less expensive futures.
The bottom line is that some trading volume will shift to futures because under the new rules futures will provide a cheaper means of accessing the FX market,” says Kevin McPartland. “These are not exotic products. FX futures contracts have existed for years providing exposure similar to that offered by OTC contracts, and among the major global exchanges, FX futures liquidity has steadily grown over the past few years. Investors are already comfortable with the products and now they will have a big incentive to make much more use of futures.”