In this piece, Phil Hermon, Executive Director, FX Products at CME Group, explains how FX Link is revolutionizing the FX swaps market by driving automation, increasing efficiency and supporting diverse use cases.
The evolution of the FX swap market (which accounts for ~50% of the $7.5 trillion-a-day OTC FX market) is at an important turning point. The changing interest rate environment has contributed to continued strong volumes in FX swaps, while also highlighting an opportunity to electronify a market traditionally traded on a bilateral, and balance-sheet-intensive, basis. All the while, the continued impacts of the uncleared margin rules (UMR) have further heightened the need to optimize margin requirements and the associated funding costs.
As the landscape has evolved in 2024, volumes in FX Link from CME Group have soared by 79% year-to-date, posting $3.6 billion in average daily notional volume (ADNV), with a single-day volume record of $13.5 billion.
This continued growth has been driven by activity across the nine currency pairs currently supported on FX Link and is underpinned by growing adoption across client segments, particularly by the sell-side community. So far in Q3, the number of banks participating has grown by almost 50% and traded volumes from banks has grown more than 6x compared to Q3 2023, which has helped to further enhance the liquidity and growth in volumes on FX Link. In August 2024, CME Group saw FX Link volumes of 59K contracts per day (~$5.5 billion notional), up +215% vs. August 2023.
Paul Houston, Global Head of FX at CME Group said: "This growth reflects the increasing need for tools that not only support market-making activity, but also help traders optimize their balance sheets and reduce funding costs. FX Link is becoming an essential part of the FX market infrastructure, and we’re seeing a broader adoption across different client segments, particularly from global banks."
FX Link’s diverse ecosystem of clients and wide range of use cases is the foundation behind these growing volumes. FX Link is regularly being used as a proxy for FX swaps risk and on the back of FX market-making activity, enabling FX traders to optimize both their balance sheet and initial margin / funding costs.
“We see multiple use cases and a clear path of potential continued growth for FX Link. FX Link allows both manual and API trading, which enables activity from STIR traders and the eFX desk alike. The mechanics of FX Link, as both a balance sheet efficient FX swap and to connect the FX futures market with OTC spot, creates several use cases for Citi to be an active participant in this market.”
— Akshay Singal, Head of STIRT, Citi
Increasing market maker capacity to trade and provide liquidity across FX futures
With an average daily traded volume of over $86 billion in 2024, CME Group FX futures rival, and in many cases exceed, the largest OTC FX spot ECNs. In addition to these volumes, the 2023 study from the BIS on the foreign exchange market concluded the following in relation to CME Group FX futures:
- “Some LPs increasingly look to exchange-traded currency futures for reference prices and for hedging their spot activity...”
- “..has led some market participants to argue that FX futures do, in some cases, lead price discovery in FX spot.”
FX Link plays a critical role in all of this as it provides a transparent and stable cash futures basis market, underpinning futures use as a proxy for spot FX risk.
Enabling EFRP growth and asset manager adoption of FX futures
FX Link provides a liquid and automated workflow for participants to optimize their FX futures position and the resulting funding costs of the associated initial margin.
A customer who builds up a significant position in FX futures can choose to a) hold and roll that risk forward, b) exit those positions using the robust liquidity in the CLOB and/or liquidity via Blocks and EFRPs, or c) can use FX Link to bring off-setting risk from OTC spot into futures (or move futures risk to OTC) in order to reduce or flatten their FX futures position.
This ability to manage the overall funding costs of holding FX futures positions enables liquidity providers to optimize the positions that they inherit as they provide liquidity to their buy-side customers. It’s one of the reasons that FX EFRP volumes at CME Group are up +88% YoY (as of August 30, 2024).
"We are pleased to see the continued growth in FX Link as a complementary source of liquidity to the OTC market and as a mechanism to help automate the trading of FX swaps. The diverse ecosystem and differing reasons for those participants to trade on FX Link makes the activity very complementary to the flows we naturally see in the OTC market, and we are pleased to be a major liquidity provider to this marketplace as part of our market-leading portfolio of electronic trading products."
— Xia Fang, eForward Trading, Deutsche Bank
Margin and credit line optimization
As a tradable basis between OTC spot and FX futures, FX Link provides a firm, transparent order book and a robust operational process that enables firms to seamlessly transition risk from OTC spot to cleared futures (and vice versa). This process can be helpful in a number of use cases, such as the following:
- A trading firm that is active in both FX futures and the OTC market, but that is approaching or hitting the limits of their bilateral credit lines or prime brokerage agreements. These firms can use FX Link as a ‘pressure relief valve’ to move risk from the OTC market to centrally cleared futures to give themselves more capacity to keep trading in the OTC market.
- A trading firm that is active in CME Group cleared FX options, but uses the OTC spot market for their delta hedging. These firms can keep establishing their positions in the manner to which they are accustomed, but can subsequently use FX Link to move the delta hedge from OTC spot into FX futures to benefit from the cross-margining efficiencies of holding the delta hedge inside clearing along with their FX options risk.
A centrally cleared and credit agnostic order book with firm pricing for FX swaps risk
FX Link provides a central limit order book (CLOB) with firm, transparent pricing that is credit agnostic, all-to-all and where the resulting positions benefit from the balance sheet efficiencies of central clearing. This construct provides much needed certainty of execution, transparency of pricing and the ability for willing firms to automate their entire trading and back office processes.
FX Link: the mechanics
- FX Link is a cleared, capital-efficient pool of firm liquidity for spot-starting FX swaps risk that seamlessly connects the OTC spot market and FX futures.
- FX Link is traded on CME Globex as the differential between FX futures and OTC spot FX, with the simultaneous execution of an OTC spot FX transaction as the near leg and a FX futures contract as the far leg.
- Nine currency pairs are currently available to trade on FX Link (G7 pairs + MXN + ZAR) and, subject to regulatory approvals, we are working to add CNH onto FX Link before the end of 2024.
- Trading can be done manually via multiple front ends (including CME Direct, Bloomberg, TT and Fidessa) and also via API - enabling automated and algorithmic trading.
- The CLOB for FX Link works on the same basis as FX futures - i.e., it is truly all-to-all, anonymous, credit agnostic and with firm, no last look pricing. These key features open the market to all participants and provide the conditions for a greater level of automation of FX swaps risk than previously has been possible.
“Societe Generale has been a long-standing provider of FX blocks and EFRPs for our customers, allowing them to trade on OTC liquidity and in an OTC manner, but ultimately then holding the positions as a centrally cleared product at CME Group. FX Link is a key tool for us in offering these services to our customers as it allows us to efficiently and seamlessly optimize the resulting positions and margin requirements that Societe Generale inherits as a result of winning customer trades."
— Chris Callander, Head of FX Trading - Europe, Societe Generale
What’s next?
FX Link is the cornerstone of CME Group’s new all-to-all spot FX marketplace, FX Spot+, which goes live for testing in November 2024. FX Spot+ seamlessly connects FX futures liquidity through implication technology. FX Spot+ will be hosted in the Chicago matching engine alongside FX futures and FX Link, and is designed to provide OTC traders with unique access by connecting spot FX and FX futures liquidity and a diverse ecosystem of clients. The advent of FX Spot+ should serve to further amplify the liquidity, volumes and trading opportunities for participants directly engaging with FX Link.
FX Link as the Electronic Avenue?
The growing adoption of FX Link across a diverse ecosystem of traders (client segments and between manual and API access) and a diverse set of use cases suggests that FX Link is increasingly playing a meaningful role to traders around the globe. The relevance of this diversity is that it creates unique liquidity and trading opportunities that do not exist elsewhere.
As such, FX Link does provide the ability to automate FX swaps trading while also bringing much needed transparency and certainty to a historically opaque price discovery process, combined with the balance sheet efficiencies of holding the forward leg as a cleared derivative.
To understand more about FX Link or FX Spot+, please contact FXteam@cmegroup.com
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.
