Derivatives traders and portfolio managers on the buy-side want to see more clearing in a variety of FX instruments, including swaptions, total-return swaps and single-name credit-default swaps (CDS), according to a new research by Coalition Greenwich.
“FX-related instruments, including NDFs and FX options, are near the top of the list,” said Stephen Bruel, Senior Analyst at Coalition Greenwich Market Structure & Technology and and author of The Future of FX Derivatives Clearing: Has the Path Been Cleared?
“FX derivatives clearing is slowly on its way to becoming an important and influential component of the FX market structure,” he said.
The report examines the drivers and headwinds influencing the growth of FX derivatives clearing and analyzes the primary reasons market participants use FX clearing, industry views on regulatory mandates to clear FX instruments, the instruments seen as most conducive to FX clearing, and the potential benefits and knock-on effects of widespread adoption.
Trade volume for cleared OTC FX has been increasing, according to the research.
While Dodd-Frank and a host of other rules have led to major increases in the clearing of OTC derivatives, the take-up in FX has been much slower, according to Bruel.
The reasons are understandable, he said: FX instruments are not mandated to be cleared; FX transactions generally have a shorter tenor, limiting counterparty risk; and certain FX transactions are excluded from the initial margin calculation.
“These, in addition to the perceived additional costs, have dampened the incentive to clear,” he said.
Nevertheless, the renewed focus on the efficient use of capital, balance sheet, credit, and collateral is motivating the FX markets to catch up.
In addition, the technology and operational foundations of FX derivatives clearing have evolved tremendously, and these changes should enable more clearing, Bruel said.
Despite the heterogeneous nature of this market, approximately 80% of the derivatives market participants expect clearing of FX derivatives overall to increase further in coming months.
Bruel said that multiple clearinghouses support this market, and more innovation from trading venues and middleware will help support the transition.
He noted that the pace for NDFs, FX swaps and FX options, for example, will all be different.
“Currency pairs also come into the equation. NDF clearing is more common for pairs such as USD/BRL and USD/KRW, for example, than for less utilized pairs, such as USD/MYR,” he said.
According to Bruel, the growth of FX clearing will have many knock-on effects.
“More clearing will not just affect margin requirements, but how and with whom the buy-side trades,” he said.
“The growth in clearing will also be accompanied by a growth in the use of resource management tools, such as those that optimize the use of capital, as the end goal is not clearing in and of itself, but more-efficient trading and investing,” he added.
