CME Group and LCH/CLS have been working on their FX options clearing solutions for some time, the latter having been expected to launch in 2016.
However, Paddy Boyle, LCH’s global head of ForexClear, says that subject to the usual regulatory approvals, its settlement solution for FX options clearing will go live before the end of this year.
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Naresh Nagia, CLS |
Naresh Nagia, chief risk officer at CLS, says the service will be open to multiple central counterparties (CCPs) and will apply to a range of FX products, adding: “In addition to our agreement with LCH, we are working with Eurex Clearing on its participation in the service.”
According to Nagia, it will deliver a number of risk benefits to industry participants.
“In the event of a clearing member failure, payment netting substantially reduces the size of the participating central counterparty’s potential liquidity shortfall, mitigating systemic liquidity disruption,” he says.
“In addition, the service is designed to work on an all-or-nothing settlement basis, which minimizes the risk arising from partial or incomplete settlement.”
CME Group was more specific in relation to timeframes, with global head of FX products Paul Houston confirming it expects to be offering FX options clearing by September, pending regulatory approval.
The initial scope will be cash-settled FX options clearing across seven currency pairs: EUR/USD; GBP/USD; USD/JPY; USD/CAD; USD/CHF; AUD/USD; and EUR/GBP.
Challenge
The challenge is that facilities need to be put in place to both manage the settlement and guarantee the delivery of the underlying currency, explains Houston.
“These measures can impose large costs on members and potentially undermine any benefits from moving into clearing,” he says. “Our OTC FX clearing offering will be cash settled to avoid these costs and complements the 26 cash-settled forwards we already offer.”
ForexClear plans to cover a broader range of non-deliverable forwards (NDFs) in 2017.
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| Paddy Boyle, LCH |
“The implementation of uncleared margin rules across the world has triggered a significant increase in member activity, with $2.4 trillion in notional cleared through ForexClear in Q1 2017 – including a record $929 billion in March,” says Boyle.
“We are working to expand the range of NDF currency pairs we clear to incorporate some of the G10 currencies this year, again subject to regulatory approval.”
An agreed settlement model for FX options opens the door for clearing of other FX products where netting benefits and margin optimization makes sense, as those CCPs looking to offer FX options clearing will also need to be able to manage the FX delta hedges (spot and FX forwards), suggests Steve French, head of connectivity and messaging at Traiana.
“FX options clearing will definitely act as the precursor for the industry to review the potential to clear multiple FX products,” he says.
In November 2013, the Global Financial Markets Association (GFMA) published the results of a 12-month study into the scale of transactions in the physically settled OTC FX options market to determine the same-day liquidity challenge associated with clearing this market.
Liquidity shortfall
The GFMA estimated that the liquidity shortfall CCPs had to demonstrate they were capable of managing could have been as high as $161 billion.
US swap data repository vanilla options data for the seven currency pairs highlighted above shows monthly trade counts as high as 31,700 in November 2016.
According to Clarus vice-president Tod Skarecky, the average trade size for each of these pairs is $30 million and the number of trades per day equates to approximately $36 billion.
“A quick look at the data shows that the market is certainly large enough,” he says. “We might question how many cash-settled options are traded at the moment, as well as the appetite within the market to cash settle their options instead of taking delivery.
“At the same time, some efficiency could exist if cash settlement was more readily available. While clearing may not reduce the initial margin on any individual trade, we can say for certain that a reduction in the number of counterparties will certainly reduce the costs of margin.”
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| Paul Houston, CME Group |
CME Group’s Houston acknowledges that since there is no regulatory mandate to clear OTC FX options, participation in this market will be voluntary and customers will be motivated by capital and margining benefits, which he agrees can increase substantially when netting against a single counterparty.
R5 CEO Jon Vollemaere cautions that the size of the FX options clearing opportunity will depend on factors such as the pairs supported.
“It also depends on the type of contracts supported by the central counterparties,” he concludes. “Then you need to add in factors like cost, margin offsets and whether or not prime brokers will be able to support this initiative.”
