The U.S. Treasury’s decision to exempt FX swaps and forwards from OTC derivative clearing requirements provides relief to businesses and other “end users” who employ them as natural currency hedges.
"It wasn't at all clear from the beginning if centralized clearing of FX swaps and forwards would make them more transparent and reduce systematic risks,” said Ron D'Vari, CEO and co-Founder at NewOak Capital. “The corporations hedging their natural FX exposures were not adequately equipped to manage the collateral posting requirements under centralized clearing."
The FX swaps and forwards centralized clearing rules would have reduced market making and liquidity activities as the trades are typically large and risks are high, said D’Vari.
“The centralized clearing exchange-like market structure would have increased the risks to the market makers and liquidity providers,” he said. “This would have discouraged them from those activities and ultimately would have increased the costs to all investors and businesses and curtailed true hedging.”
The Treasury Department acknowledged as much in its “final determination” to exempt FX swaps and forwards.
“While central clearing requirements will strengthen the rest of the derivatives market, the potential benefit is reduced in the FX swaps and forwards market because existing practices already limit risk and also ensure that the market functions effectively,” the determination said.
Noted D’Vari: "The U.S. Treasury decision removes a major regulatory uncertainty from the market place. This should help the fixed income markets that are already challenged by increased sovereign risks, not to mention the Fiscal Cliff."
Wholesale brokers in particular are critical of what they view as attempts by regulators to impose a market structure that was created for the futures industry on to the OTC swaps markets, which, they say, is fundamentally different.
“Different execution models will work for different swaps based on liquidity,” said Rick McVey, chairman and chief executive of MarketAxess, an operator of a U.S. electronic fixed income exchange, at last week’s Sefcon III conference. “In the debate of futures models versus OTC, we want a level playing field on things like margin calculation and taxation, so that OTC can compete with futures.”
FX swaps and forwards markets are being made more transparent and liquid through open platforms and live pricing information, said D’Vari. “There are many private electronic FX trading platforms that are looking to add derivatives capability, and allow buyside to buyside trading as well as encourage market making in more anonymous basis."
This is also the case in the FX spot market.
RTS Realtime Systems Group and Squared Financial Services Ltd., a broker offering ECN-style trading across a broad mix of liquidity pools, have gone live with an algorithmic trading system featuring spot FX and precious metals.
Squared Financial is a specialist provider of over-the-counter spot FX and metals markets, including gold bullion. With three algorithmic trading platforms, RTS offers connectivity across asset classes to more than 135 marketplaces globally.
Andy Woodhouse, managing director of Asia Pacific for RTS, said in a statement: “We expect that this initiative will be very attractive to those who want to expand into spot FX and metals either to hedge their currency exposure or to participate in the burgeoning gold and FX markets.”
