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CME initiatives coalesce around spot FX basis spreads

At its launch in March, CME FX Link was heralded as the first-ever central limit order book between OTC spot FX and FX futures markets, enabling more efficient access to FX futures as part of a wider trading strategy.

According to Paul Houston, global head of FX at CME Group, the creation of this linkage has already started to improve the ability of market participants to manage market exposures and credit utilization across the two markets.

The offering serves as one of the first electronic central limit order book liquidity pools for managing FX swaps exposures, making it a highly complementary tool for participants in that market, he adds.

When asked to what extent FX Link has enabled non-bank firms to access the swaps market, Houston says it has seen adoption from a range of client segments, inclusive of providing a conduit for non-bank firms to offer liquidity to FX swap market participants in a centrally traded environment.

“More generally, banks and other client segments are attracted by the development of a credit and capital efficient electronic central limit order book to manage FX swaps exposures,” he adds. “No such venue exists in the marketplace today.”

One of the most interesting developments was always likely to be how overall use of FX futures has been affected, given that market participants can switch OTC exposures into listed and – where relevant – listed back to specific OTC dates.

We now have a liquid front four months of the FX curve, facilitating trading of more granular forward date and active spread trading outside of our traditional roll periods 

 – Paul Houston, CME Group

“In the immediate term, this increases the opportunity of market makers to use our deeply liquid FX futures market to hedge their OTC positions with FX Link, facilitating position transfer to optimise credit lines, margin and settlement exposures,” says Houston.

The company has previously referred to European asset managers joining the marketplace ahead of the introduction of mandatory variation margin on physical delivered foreign exchange forwards. As the product continues to grow it expects more buy-side participants to come on board.

“For example, asset managers utilizing algo spot execution can swap their OTC spot trade into an FX future, accessing central limit order book pricing, the benefits of central clearing and automated electronic workflows,” says Houston.

When CME Group fleshed out its plans for FX Link last year, it also confirmed that it would be offering implied pricing across FX monthlies to offer end-users additional maturities to execute and with the aim of building a broader spread market.

Next step

Houston described implied functionality as the next step in building the marketplace, allowing it to optimize liquidity between spread and outright markets.

“We now have a liquid front four months of the FX curve, facilitating trading of more granular forward date and active spread trading outside of our traditional roll periods,” he says. “This is very complementary to the FX Link initiative, collectively offering an efficient venue to manage forward and swaps risk across the curve.”

The other development that has kept CME Group in the news (aside from its intention to acquire NEX Group), is its plans for FX options clearing. The firm has developed an OTC cash-settled FX options clearing offering starting with seven currency pairs and it reports that a number of banks are already submitting daily volatility surfaces.

“As market participants investigate the full costs and complexities of a physical clearing solution, it has given us a chance to demonstrate the capital, cost and margin efficiencies of our cash-settled FX options solution,” says Houston.

CME has also recently made a number of changes to its listed FX options marketplace. These include moving the options from American to European style and launching additional maturities. The company is also in the process of changing its expiry time from 2pm Chicago to the OTC standard 10am NY.

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