LONDON, May 21 (IFR) - Foreign exchange dealers are
preparing to overhaul business models to keep up with the
largest changes the industry has undergone in more than two
The sector breathed a collective sigh of relief when the US
Treasury proposed a clearing exemption for FX swaps and forwards
on April 29, but it is far from business as usual for dealers.
As well as forthcoming regulation on options and
non-deliverable forwards, electronic trading is growing across
all products at a dizzying pace. The FX derivatives market is
evolving into an entirely different animal -- and fast.
While keeping pace with the increasingly larger volumes
being executed on electronic platforms, FX dealers will be
forced to divide their business between products that will be
cleared through central counterparties and executed on swap
execution facilities (notably FX options and non-deliverable
forwards), and those that won't.
"We're going to see a bifurcation of the FX business model,"
said Kevin Rodgers, global head of FX derivatives, spot and
e-trading at Deutsche Bank in London.
"Certain products in certain jurisdictions with certain
clients will go to an exchange, similar to the equities world.
And big portions of the market -- spot, swaps and forwards but
also parts of the derivatives market will be done bilaterally,
like the old model."
E-MIGRATION GRABBING ATTENTION
Normally, regulation of this magnitude would be the main
focus for dealers. But this regulatory push comes at a time when
much of the market has been migrating on to e-platforms of its
own accord. Computer power has boosted dealers' abilities to
offer execution on e-platforms, as well as managing risk in a
more automated fashion.
Deutsche Bank estimates that 20-30 percent of its total
options flow is now executed on its e-platform Autobahn compared
with scarcely anything in 2008. Meanwhile, about 80-90 percent
of its spot volumes and 60 percent of its swaps and forwards
volumes are executed electronically. It is hardly surprising
then that dealers are throwing cash at their e-platforms by the
"We're still investing heavily in our e-commerce platform
Morgan Direct, both on the technology and the people side," said
Kayhan Mirza, global head of FX options trading at JP Morgan in
London. "An increasing amount of our business is priced,
executed and risk-managed on that platform. We believe that
continued investment makes a lot of sense, regardless of the
ultimate definition of an SEF."
Part of the problem, therefore, is that dealers must
second-guess the final shape of regulation. Participants are
confident that the US clearing exemption for swaps and forwards
is in the bag, but will not find out for certain until the end
of the month.
Meanwhile, the SEC and the CFTC currently have different
definitions of a SEF, although it seems likely banks' own
e-commerce platforms will be ruled out for executing clearable
trades -- magnifying the significance of clearing exemptions for
products that are already heavily e-traded. On top of this
uncertainty, Europe has yet to pronounce on FX clearing.
"There is still uncertainty, but if the Treasury exempts
swaps and forwards, we'd expect Europe to follow suit," said
David Clark, chairman of the Wholesale Markets Brokers'
Association in London. "However, we can't exclude the fact that
Europe may not include options and NDFs in MiFID II. A further
potential difference may be the position that Europe takes on
single-dealer platforms, because there appears to be little
appetite to ban them."
In any case, e-commerce platforms will still add value
regardless of the final SEF definition, said Vincent Craignou,
head of FX and precious metals derivatives at HSBC in London.
For example, single-dealer platforms can be used to root to
SEFs, he said, and clients should still be able to glean value
from the platform's execution and risk management capabilities.
This means that dealers are still piling money into their
e-platforms and systems despite the uncertainty, looking to
attract clients as well as shouldering the costs of connecting
to multiple CCPs and SEFs.
But while the FX derivatives market is evolving, some things
should stay the same. Rodgers at Deutsche Bank signalled that
electronic execution of vanilla options would continue to work
on a request for quote basis rather than shifting to a central
limit order book, as clients value flexibility in strikes and
tenors too much.
Likewise, dealers concurred that clients would still execute
the largest options tickets through voice broking rather than
clicking and trading, out of comfort if nothing else.
The impact of clearing and SEFs on options liquidity is a
hazier subject. Proposed reporting requirements for cleared
trades have led dealers to fear that they may not be able to
warehouse risk as effectively as before, leading to rises in
prices to compensate.
"For short-dated options on liquid currencies, this
transparency should help market liquidity," said Craignou at
HSBC. "But there is a risk that longer-dated contracts for block
trades, and potentially for minor currencies, will become more
illiquid as banks will have to widen prices to mitigate the
effect of increased disclosure."
Another looming question is how effective e-trading
platforms can perform in stressed market environments. FX is
notoriously sensitive to market shocks and can swing violently
in short periods of time.
Perhaps not surprisingly then, there are anecdotal reports
of various e-platforms temporarily pulling options prices on
days like the flash crash or the Japanese earthquake.
"It can be very difficult," admitted Craignou. "My
temptation in such a scenario would be to switch off streaming
and rely on good old-fashioned traders to generate prices."
Nevertheless, continued investment in systems and advances
in technology will mean automated risk management will only grow
in prominence in the future.
"More and more price making and risk management tasks will
be handled by computers, as we've already seen in the spot
market," said Rodgers. "That's not to say that human traders
will become redundant, though. Trading is a bit like flying a
plane. You can put it on autopilot a lot of the time, but
ultimately you need human beings who can understand the risk and
make the right judgements.
(This article originally appeared in the May 21 issue of the
International Financing Review, a Thomson Reuters publication: