The Last Look…
Posted by Colin Lambert. Last updated: March 14, 2023
The evolution of the FX market structure has always continued at its own leisurely pace, but I sense we are on the brink of generational change in the FX swaps thanks to different influences and initiatives coming to a head at the same time – and if you want an indication of what I am talking about look no further than the top two stories in The Full FX weekly email in which this very column is included.
The driver, although it is very much seen as a “slow burner” in many eyes, is SA-CCR, or the Standardised Approach to Counterparty Credit Risk. There seems little doubt, talking to people of all sides of the industry, that the US banks have been feeling the pain of SA-CCR, especially in the FX swaps market; nor is it in dispute that these banks are the canary in the coal mine.
European banks especially, are well aware the same issues are heading their way next, and even those banks in jurisdictions that are further behind on SA-CCR, are apparently more willing to engage on potential solutions to ease what they know will eventually be the same pain.
The change is not just a result of regulation, however – although that is certainly the likely trigger – for other initiatives have also been required to gain sufficient traction.
On the trading front, more needs to be done on the dynamic credit front – I have spoken to several senior managers at platforms, and when asked about swaps they all have a variation on the same answer – ‘we need to solve for credit’. I have long been a proponent of the Cobalt idea around dynamic credit, nothing since prime brokerage will do more to democratise market access, and by association liquidity in this market.
This does not, I should stress, mean that average trade sizes collapse in a heap and a large number of nimble, smaller players enter the market. Customers, by and large, as well as the major players, want to deal size in FX swaps, they want to clear the risk off their books as efficiently as possible and do not want to worry about such things as market impact.
In spite of the credit issues, the evolution has been also helped by platforms focusing more on FX swaps, notably 360T’s SUN, which has helped drive decent growth in the business. I remain of the opinion, as I have written before, that the solution most desired by traders is one that blends the ability to trade at mid on 360T, with the ability to build ticket sizes as can be done on Refinitiv Matching, but either way, the platforms are coming to the party and seeking to facilitate more e-FX swap trading between banks.
The third part of the puzzle, something we got news on this week, is in the post-trade. Compression services and the optimisation of forward books is a crucial link in the chain, one that has been operating for some time, but now we are starting to see working models emerge that add an extra dimension. The latest iteration is Quantile’s initiative with LSEG stablemate LCH ForexClear.
Just under a year ago, I wrote about the growing openness to clearing of FX swaps, and we are now a Proof of Concept on and have “smart clearing” as ForexClear calls it, which represents a wedge in the door. The clearing of FX swaps is not a “slam-dunk” however, for there remain valid and reasonable questions on the cost involved around margining. That said, “smart clearing” is a shrewd initiative – not least because it effectively says to market participants “we understand that clearing is not a panacea”.
Instead of trying to change the world alongside Quantile (sources at ForexClear stress that the business is open to cooperation with other service providers), the business seems to be trying to change those areas of the business it can. Importantly, however, these areas are not on the fringes of the market, they are at the heart of the system. Where the real benefits will be felt is in the banks.
Innovation with an eye on the client is all well and good, but it does seem now that, finally one might add, more banks are waking up to innovative ideas that make their world better. In this case SA-CCR may have been the trigger, but the other initiatives also have played a crucial role in one important area –changing the mindset. A lot of the changes being discussed are incredibly useful for both electronic and voice traders, the latter remain an important factor in the synchonicity that appears to be in play.
I wrote many years ago at Profit & Loss that I believed any change in the FX swaps market structure would require firms working together, a much more collaborative approach. Scaling has been an issue for some of the ideas out there, but in reality there was no one thing that could bring these initiatives together. SA-CCR, for all that some may criticise it, seems to have done that, hence my assertion that we could be on the verge of generation shift.
Of course, in the interests of balance, I should point out that I have been predicting just such a change for a few years now, but at times like this I like to fall back upon (and paraphrase) the fountain of philosophy that is Monty Python’s Life of Brian. “This is the idea that is going to change the world – I should know, I’ve followed a few!”