Derivatives Specialist NBLPs Make FX Options Push

Something the FX market witnessed 20 years in spot is emerging in FX options as non-bank players eye the market. But as Eva Szalay reports, the names on the tickets are different this time.

Non-bank market makers have a new target market: FX options. Rather than the big players from the spot markets, however, the challengers are a group of equity derivative specialists who are finding that the market structure suits them just fine.

Companies that are already active in the space such as Optiver are ramping up their activities in liquidity provision not just in terms of geographical coverage but also the type of counterparties they deal with. Others, such as fellow Dutch shop IMC are gearing up to go live before the end of the year and they have ambitious plans. The Full FX is also aware of at least one more non-bank liquidity provider (NBLP) with plans to enter the FX options market.

What’s going on? Why would a bunch of mostly Dutch exchange-traded derivatives specialists show interest in a historically chat-driven, highly fragmented and as a market maker, capital intensive business? And where are the heavy-weights from spot markets?

The answer is (as usual) regulation. The introduction of uncollateralised margin rules for OTC trading has pushed more trading towards exchange-traded and centrally-cleared markets and has dented principal market makers’ appetite to service certain segments. This has opened up a niche for specialist providers, first in the inter-dealer market and increasingly in the D2C space through partnerships and white-labelling services.

“The FX market presents an opportunity for the next generation of leading market makers to provide liquidity by leveraging advanced technology and risk-management techniques developed in the equities markets and applying it to FX,” Ramon Puyane, Head of FX Trading at IMC tells The Full FX.

IMC, which is planning to go live in the fourth quarter, and its peers, are there to plug the gaps. It will start with G10 OTC vanilla options and then aim to expand its universe of currency pairs in the first half of next year. “Our goal is to provide consistency and speed in pricing,” Puyane adds.

Already a Booming Business

According to data from the UK’s Joint Standing FX Committee April 2024 survey of FX turnover, the top 12 dealers held more than 96% of the OTC FX options market share in 2021. While options can be expensive from a capital requirements point of view, they provide a potentially lucrative source of business as well. As clearing gathers steam in the D2D segment, NBLPs are ready to chip away at the dominant share of bank providers. Large existing NBLP spot market players appear to have no plans to go large in a space that’s not fully electronic, leaving the door open for derivatives specialists.

“What we saw in the OTC FX options space was a market still remarkably fragmented relative to other major asset classes”

John Rothstein, Optiver

“We’ve built our entire tech and process around [providing liquidity in derivatives] and we’re among the top options liquidity providers across most major asset classes globally,” says John Rothstein, UK managing partner and global COO at Optiver. He adds that his firm is the number-one ranking liquidity provider in listed FX options on the CME and a major liquidity provider in the OTC market, specialising in vanilla options with maturities of up to one year.

The firm has been market making FX options on the CME since 2009 and initially entered the OTC market trading bilaterally with banks. Since 2019, it has been an active liquidity provider in the interdealer broker market. “What we saw in the OTC FX options space was a market still remarkably fragmented relative to other major asset classes, with most end users able to trade with only a small subset of liquidity providers due to credit constraints or operational capacity,” Rothstein explains.

That’s changing.

A Sizeable Opportunity

FX options volumes are booming due to the return of interest rate differential and monetary policy path changes in major economies. Geopolitics and a record number of elections this year have also proved to be a boon for volumes, which have more than doubled in the last three years in each of the FX market’s mor centres, the UK, US and Singapore.

The market structure is also in flux as the impact of UMR filters through and changes the economics of the space. Cleared FX options volumes are sharply higher than two years ago, with LCH-owned ForexClear notching up six consecutive record quarters by the end of July and it cleared $1.2tn worth of these contracts in the second quarter of this year. It has also hit three successive new highs for FX options volume in June, July and August 2024.

The listed market is also booming, with a 24% increase in volumes on the CME in July compared with the same month last year and a 13% rise when looking at year-to-date activity in 2024.

New venues and partnerships are springing up, buoying the trend towards more electronification in the space. SpectrAxe, an all-to-all FX options platform launched earlier this year, multi-dealer platforms that offer the contracts are reporting significantly higher volumes, and OptAxe is also nearing launch as it finalises regulatory requirements. Existing venues such as DigitalVega are also pushing ahead, with the OTC FX venue now offering eligible participants the chance to negotiate and trade options on the CME via the platform.

Extending Their Reach

IMC’s Puyane says that his firm will start with a sole focus on the D2D market, which has faced “significant challenges” since the financial crisis as liquidity providers scaled back or disappeared at a time when demand from clients was on the rise. These imbalances made it increasingly difficult to offer competitive pricing and efficient trade execution, exacerbating a liquidity crunch in the market, he adds, noting that the IDB segment is where IMC can make its most immediate impact.

“There are currently only a small number of non-traditional participants active in the options market but we have seen others achieve a lot of success in the FX spot market”

Ramon Puyane, IMC

Optiver, meanwhile, is focusing on expanding its reach to the client side. In recent times, the firm focused on expanding its liquidity provision via agencies and through white-labelling, or arrangements which see the LP partner with banks that leverage their relationships and credit lines while outsourcing pricing and risk management to Optiver.

The white-labelling offering allows regional banks, for example, to access reliable and competitive pricing for FX options, which frees them up to focus their resources and efforts on sales distribution and higher-margin trading, Rothstein says.

The firm has plans to widen its currency coverage and it will start making prices in Asian hours, “with the goal of getting our liquidity in front of more end users and enhancing the transparency, accessibility and overall liquidity of the FX options market.”

More Competition Ahead

The success of these efforts remains to be judged in the coming years. For now, it seems that FX options will get a whole lot more competitive in the coming years.

“The competitive landscape is small but with the potential to grow. There are currently only a small number of non-traditional participants active in the options market but we have seen others achieve a lot of success in the FX spot market over the last few years,” IMC’s Puyane says.  “This should translate to more entrants in the options market in the coming years.”