The Last Look…

I know I need to get out more, but I was reading the latest minutes published by the UK FX Joint Standing Committee, it’s the usual bare bones, but the section of clearing in FX was reasonably insightful – not least because it did not fill me with confidence that the influence of clearing will extend much beyond the current listed futures, NDFs and some options.

It feels like we have been talking about clearing in FX for ever, in reality it has been a decade and more of course, so long enough, but progress continues to be painfully slow – if it exists at all. As volumes in NDFs grow so too does the clearing opportunity, the take up of options clearing is a struggle and as for FX swaps, a product many thought was ripe for the process…next to nothing.

The JSC minutes reflect on a discussion that highlighted the “significant spikes” in margin requirements that offset the benefits on capital requirements, as well as the high cost to clients for no discernible benefit. It was also noted that alternative methods exist for clients to reduce their credit risk outside of clearing and that many clients – and this is not a new story – cite operational constraints.

The fact remains, if clients have to do the heavy lifting on anything – let alone something that will make minimal difference to their broader business – little, or nothing, is going to get done. Equally, banks seem to recognise more now that costs cannot be absorbed into the spread so are likely to charge the requisite fees to the clients – who will, naturally, be reluctant to pay them for the reasons mentioned before.

There is also the fact that for a large – and lucrative – section of the client base, FX swaps trading is all about cash flow – although it should be noted, as we enter a period of monetary policy volatility, more traders are likely to have a view as well – so why complicate matters unnecessarily? Especially if the clients concerned are not in scope of regulations aimed at increasing clearing.

This is not to say that the idea of clearing FX swaps is dead in the water – there are still opportunities, not least more asset managers coming in scope of UMR at Stage 6. From a client perspective at least, September 2022 looms as the critical month for FX clearing.

Although the economics probably need to be nuanced (yes, that’s a posh way of saying made cheaper), there is an area that seems ripe for clearing – inter-bank transactions. This is not the first time I have written about this, but looking at some data it seems even more obvious that before – perhaps the FX industry’s obsession with clients is blinding it to the possibilities (along with that cost of course).

Taking data from the JSC’s semi-annual turnover survey – the UK is the only centre for which sufficient detail is available – FX swaps turnover with other financial institutions, hedge funds, asset managers etc, has risen since October 2015, by some 16%. With corporates it has actually dropped a little, by some 5.5%. Look at the same data with banks, however, and it’s a different picture. Non-reporting banks turnover is up almost 11% and between reporting dealers? Just the small matter of an 80% increase in activity between October 2015 and October 2021.

In notional terms, $1.2 trillion per day is transacted in the UK alone between banks, this compares to just over $210 billion involving clients. A lot of this is at the very short end, but enough isn’t to make clearing a competitive option surely? Also, this would suggest that while the conversation is very much shaped around clients, should the industry not be working harder to offer banks a proposition they can’t refuse?

The story is fairly similar in NDFs – a largely cleared product. Turnover in the UK has increased substantially, and it’s all banks. Other financials’ turnover is up about $4 billion per day from October 2015 and non-financial by $6.5 billion, but again, these numbers are dwarfed by the rise on other banks turnover ($13 billion per day) and reporting dealers ($49 billion – a three and a half times increase).

NDF clearing appears to be a success story – the majority of flow is executed by banks, therefore the clearing flow largely comes from that sector, thus it seems fair to assume that the same could happen in FX swaps. The big difference is, of course, one product is subject to a clearing mandate, the other isn’t – largely because of the impact it would have on the buy side.

There are firms that desperately want clearing in FX swaps, not least because it would open up that market to them – notably at a time when markets are starting to move and, in all likelihood, spreads are likely to widen in the months and years ahead. The problem for these firms is that the buy side – the business everyone wants – doesn’t perceive it has a problem in FX swaps, and if it does, there are cheaper solutions to meets the majority of its needs.

It will be interesting, therefore, to see how this situation evolves. It seems to me that the industry – I should note the 360T MidMatch venture as being a exception – is largely looking in the wrong direction on clearing. NDFs and options are what they always have been – and are likely to remain – sideshows. FX swaps remains the big target, but if UMR 6 doesn’t get it over the line, then I am not sure what, if anything, will.

colin@thefullfx.com

@colinlambertFX