The Last Look…

New platform launches in FX have, in recent years, tended to be low-key events, largely because everyone understands it will take time to create a position in the market, but today’s launch by CME of Spot+ is a little different – not only does it have very strong foundations on which to build, but it has challenges of a different nature.

The foundations are obvious – CME has the largest FX futures franchise in the world, but in banking terms at least, only taps into a relatively small percentage of participants. It is true that those players responsible for the majority of volume are already connected to CME, but as I have been banging on about for some time now, the FX market needs to maintain a degree of diversity – it is not necessarily healthy that volume coalesces in perhaps four or five players.

This is where Spot+ has the potential to change the business – if CME is able to attract enough tier two and three banks to the venue it will not only introduce a completely new source of business for its market makers – including a lot of hungry non-bank firms keen for volume – which will increase overall volumes, but it will also challenge one of its close competitors in LSEG FX.

This is also, however, one of the challenges for CME – overcoming history. EBS has made several attempts to build out its core franchise by targeting pairs that were historically Reuters’, and it has failed every time (the same is also true in reverse). There is a tacit understanding in FX circles that two primary venues (three over the past decade if one is to include CME) are beneficial to the market, and no development to date has managed to shake that idea. Brokerage holidays, different minimum amounts and ecosystem settings – they have all been tried by one firm or the other and barely moved the needle of stability.

This is why Spot+ is a good idea, not only does it allow CME to target new currency pairs, but it can do so with the calling card of existing volume from the futures world – in the case of AUD and GBP about 10 yards worth on a good day. A lot of participants in those markets neither have the inclination or resources to connect into the futures world, but to an OTC venue, using existing pipes? That is a different value proposition altogether.

It will be interesting to see how Spot+ plays out in the G3, in particular EUR/USD, a traditional stronghold of EBS Market. During the “Liberation Day” mayhem, CME printed over $122 billion in EUR/USD, which was more or less equally shared between the OTC and futures platforms. This means Spot+ has to work harder here, I would suggest, purely and simply because the existing markets are recognised as “go-to” venues for EUR/USD. Yes, the same argument exists for bringing newer players to the EUR liquidity pool, but there is not the immediate and obvious benefit that could be seen in, for example, the Commonwealth pairs.

If Spot+ is indeed a success in EUR/USD, therefore, the spectre of cannibalisation – something that has been forecast in some quarters about the launch – raises its head. If the new venue builds traction in Commonwealth, Scandi and EM pairs, it will, in all cases save for CNH perhaps, be accretive to the business.

It is natural, I suppose, to look at declining volumes across EBS over the past 15 years and see a case for Spot+ taking over, but to me that ignores the value of the CNH and JPY franchises, both of which are driven by unique forces. Also, while it is true that EBS has seen a sharp decline in activity over the past 15 years, from its heyday of $150 yards a day, CME’s futures have, in notional terms, also declined, albeit by nowhere near as much. EBS average daily volume for the five years 2015-19 was $85.8 billion, this dropped over the next five years to $63 billion, At CME, the same numbers are estimated to be $89.3 billion and $86.2 billion. The introduction of smaller contract sizes has made some of the historical data at CME hard to discern in notional terms, but it’s fair to say, over the last decade, while it has held its own, it hasn’t grown.

This means, rather than cannibalise the EBS FX business, Spot+ could add to it – and indeed the futures – but, to repeat myself, I think this will largely be achieved through establishing itself as a “go-to” venue for a wider range of pairs that have, historically, not been strong on EBS.

Spot+ has to prove that it is not a “shark tank” and that it is a “fair” venue to all participants, not just those with microwave towers

The opposing argument is potentially fascinating, however. Would a successful Spot+ emerge as the number one CME FX venue, eclipsing both existing franchises? This is a long way in the future naturally, but at the moment CME offers no-last look liquidity for around $150 billion per day – bring those two together, with the added bonus of new currency pairs (not to mention the data, which could eclipse every other factor), and does Spot+ come to dominate? In a world in which firm liquidity is becoming more popular and fashionable again, does the market gravitate there? And if so, what of EBS and CME FX futures? Well, EBS could indeed disappear in this scenario, and CME FX futures could become a largely retail-orientated venue, but enough travelling down that particular rabbit hole!

The very fact that so many are interested in Spot+ and that there is so much chatter about its potential, suggests to me that CME may have a great opportunity on its hands. So what needs to happen for that opportunity to pay off?

Firstly, Spot+ has to prove that it is not a “shark tank” and that it is a “fair” venue to all participants, not just those with microwave towers and more. I remember writing some 20 years ago that FXMarketSpace could be 10 years ahead of its time, because the banks simply were not ready to compete in speed terms, with the HFTs that were infesting FX at the time. Ignoring the fact that I am 10 years out (what’s a decade between friends?), some banks can, and do, compete in this area, but the majority still do not. This means that those regional players, who I believe will be the measure of success for Spot+, have to be able to actually get business done. They don’t want to be pipped, or see the market slip away every time they post some interest.

Overall, I would say I am bullish on the prospects for Spot+, mainly because of the opportunity it affords in broadening CME’s reach into OTC markets, but there are obstacles that need to be overcome

It was heartening to hear from Paul Houston, head of FX at CME in this video interview, that during the testing period, passive interest did seem to gain some popularity, I would humbly suggest it has to at some level for Spot+ to prove it is a venue that will work for players who don’t spent billions on tech.

Secondly, the tech “lift” for new participants cannot be too onerous, and again, the experience from the testing seems to suggest that enough banks managed to connect up and trade without too much effort.

Thirdly, CME has to establish in peoples’ minds that Spot+ is an OTC venue. This sounds strange, but to hark back to FXMarketSpace, one of the problems was that too many saw it as a futures venue masquerading as an OTC platform.

Finally, CME has to have patience. I wrote at the launch of the firm’s FX Link platform in 2017 that both it, and the market, would need to have patience and wait for the world, largely in the form of regulation, to come to it. While Spot+ does not really need to worry too much about regulation, CME will have to understand that volumes may not come pouring through the door from Day One – these things take time, and it must give Spot+ sufficient opportunity.

Overall, I would say I am bullish on the prospects for Spot+, mainly because of the opportunity it affords in broadening CME’s reach into OTC markets. There are obstacles that need to be overcome and a lot of work to be done to establish it in the framework of the industry, but it has, undoubtedly, no little promise.

In terms of how we will actually measure success? That is a little harder, however at a very simple level it should be increasing CME’s overall FX footprint. If Spot+ brings new players to CME’s markets, and ticks up volumes from the current $150 billion per day range, then it is on the right path. Whether or not it is a success can only be judged in four or five years’ time when we reassess the FX market structure, and the role, if any, played by Spot+ in changing it.

colin@thefullfx.com