Central clearing of FX products remains non-mandated, and as such, any clearing activity is “voluntary” to achieve an efficiency otherwise unavailable via bilateral or intermediated OTC activity. 2022 saw a high-water mark in adoption and usage of cleared CME FX products, with over 90,000 unique traders involved and over $40 trillion in gross notional cleared. This large, hugely diverse, and growing ecosystem of traders spans across both geographies and client segments – including major swap dealers, regional banks, hedge funds, and asset managers.
The chart below shows the growth in average open interest of FX products at CME, and as of March 7, 2023, buy-side entities were holding 48.2% in EUR/USD (which is the most actively traded currency pair at CME – averaging over $33 billion per day in 2022). The drivers behind this activity are almost as varied as the ecosystem of traders involved, but prominent catalysts include the ability to trade without an ISDA, access to unique liquidity, margin (UMR) and capital efficiencies (SA-CCR), and also the operational benefits of leveraging the well-established FCM clearing model.
With the growth in client adoption has also come the need for evolution of trading flexibility. The central limit order book (CLOB) is a critical cornerstone to the CME FX offering, providing firm, no-last-look pricing 23 hours per day for truly all-to-all, credit-agnostic price discovery and risk transfer. The CLOB continues to offer unique liquidity for both establishing, rolling and closing risk across a range of currency pairs and products covering FX forwards, NDF and options risk (find more details on CME CLOB liquidity and activity here). But while critical to the offering, the CLOB is not how every trader wishes to interact with the market. Depending on the trade size, market conditions, currency pair, and the immediacy of a trader wanting a risk transfer price, traders may instead wish to utilize disclosed, OTC-style trading with chosen liquidity providers who can lean on OTC liquidity to price a given transaction.
This OTC-style trading of CME cleared FX products saw large scale growth during 2022, with overall activity up 76% and also the panel of liquidity providers offering the service growing to a list of over 20 names (directory of those names available here). Both FX options and FX futures across over 25 currency pairs were traded in this manner during 2022, which helps further illustrate that pairing OTC-style execution with the benefits of a centrally cleared wrapper for the resulting risk is a topical and relevant mechanism for traders to be aware of.
While the post-trade processing of all cleared trades remains highly efficient and automated irrespective of how and where a trade was traded, the execution process for these OTC-style trades (referred to as “blocks” and “EFRs/EFPs” in Exchange terminology) historically has been somewhat manual. The customer has contacted their chosen liquidity provider or broker to start the negotiation process, with dialogue typically happening on a one-to-one basis either on the phone or over an electronic “chat” service. Once a price was agreed upon and a trade executed, the liquidity provider would then typically manually key the trade details in to both their risk system and also into a GUI to communicate the trade details to CME for clearing. While this process worked, and continues to work today, it also had some inherent limitations on scale, and for clients who wished to automate their trading activity.
Growing volumes along with growing demand from both hedge fund and asset management customers have combined with other catalysts such as SA-CCR, which motivates dealers to capitalize on central clearing to benefit from the netting and treatment of margin to reduce the impact of winning client trades (in particular, FX forwards) on their balance sheets. The combination of these points has resulted in more investment, and so more choice, for customers in their execution “handshake”. There are three main areas that highlight this investment and the execution flexibility now available to traders.
CME Direct – Directed RFQ functionality
“CME Direct is the proprietary front-end trading platform offered by CME Group. The platform provides a vast amount of trade data, analytics, and trading tools to transact in CME Group markets across asset classes, but in relation to sourcing additional liquidity to augment the CLOB or to achieve a risk transfer price it offers Directed RFQ (DRFQ). DRFQ allows a trader or broker to select a panel of liquidity providers to initiate a Block RFQ against those chosen LPs, compete the pricing side by side, negotiate the terms, and ultimately execute and report the trade. All of which is done using a structured, fully electronic workflow that captures and automates the entire workflow from initial request through to the submission of the trade to clearing. Audit trails and timestamps are fully automated, ensuring best execution requirements can be evidenced with ease.”
— Stewart Jardine, Head of Platform Solutions, CME Group
Liquidity provider technology work – Automation and enhanced single dealer platforms
From the list of 20+ liquidity providers who are live for the OTC-style execution of cleared FX trades at CME, a number of those, including BNP Paribas and Morgan Stanley, have invested in providing automated solutions for their clients and ongoing support via voice execution from their global sales teams. The automated solutions typically deliver a complete end-to-end workflow that is either over API or via a single dealer platform. This setup ultimately serves to remove direct human engagement and manual “keying in” of a trade by the liquidity provider.
While the offerings have nuances and differences, both BNP Paribas and Morgan Stanley have created solutions for clients in their respective single dealer platform and via API. Both firms have enhanced their single dealer platform (Cortex FX for BNP and Matrix for Morgan Stanley) to allow clients to see and access live, tradeable prices for FX blocks derived by the bank acting in principal capacity and leaning on OTC market liquidity. Clients simply click and trade in Cortex FX / Matrix, and the system will automate the booking and reporting of the trade to CME for clearing.
In addition, both firms are offering various FX EFRP services that include the use of algos and are delivered via API directly to clients with the bank acting as a principal liquidity provider, leaning on the OTC market for pricing. All these services can help to shrink the trade lifecycle and create robust automation – removing the need for any human or manual interaction by the end client or the liquidity provider.
Outside of BNP Paribas and Morgan Stanley, other liquidity providers are building or have built similar automated solutions for their customers, and they can be contacted directly for further details using the names here.
Aggregators / multi-liquidity provider platforms
CME is working with several aggregators/multiple-liquidity provider platforms on further enhancing and automating OTC-style trade workflows. This includes Digital Vega, one of the largest multi-liquidity-provider-to-customer platforms in the FX option space.
“Digital Vega are excited to be partnering with CME to provide clients with a fully automated FX option block trading service, allowing seamless pricing, execution, and reporting of cleared FX options.
Historically, blocks have been transacted in a largely manual manner over legacy trading venues such as voice or chat – by adding the ability to trade CME blocks on Digital Vega’s market-leading OTC FX option multi-dealer platform, we aim to provide a seamless block execution solution to both buy-and sell-side participants. Pricing and execution will be in a format familiar to OTC participants, with deep “OTC-style” liquidity from a broad group of market makers but booking to a single central counterparty – mitigating counterparty credit risk and generating potentially significant capital, margin, and operational efficiencies. Transaction reporting to CME ClearPort will be automated and immediate, with detailed post-trade reporting and analytics available.”
— Mark Suter, Founder, Digital Vega
Bottom line
Catalysts for change are present and are growing more pronounced within the global FX market – in particular the ongoing impacts of the Uncleared Margin Rules and also in relation to bank capital via SA-CCR. CME FX products, which cover FX forwards, NDF, and options risk, saw 24% growth in 2022 – totaling over $40 trillion cleared and with more than 90,000 traders involved. The ability to access the unique liquidity and clear benefits of CME FX products is now more flexible than ever. Continued investment by liquidity providers and platforms now provides clients with the ability to fully automate the process of OTC-style trading that leans on OTC liquidity but ultimately holds the risk within a centrally cleared CME product.
The clearing of FX products will not suit all customers or all trading strategies, but the available liquidity and potential benefits of clearing can be used as a complement to holding risk bilaterally. Additionally, clearing can help mitigate specific challenges like margin optimization, freeing up bilateral credit lines, or the ability to trade without an ISDA.
Contact the CME FX team or any of the 20+ liquidity providers in the CME FX directory to discuss this topic in more detail.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
