Although the vast bulk of activity in foreign exchange takes place in the over-the-counter market, significant volumes are also transacted on the CME. The exchange’s FX product suite is now so successful that is possibly the second-largest trading venue, other than on the banks’ own proprietary systems, after EBS. The CME’s revival has been staggering. In April 2001, its average daily turnover amounted to just $6 billion a day. This August, that figure had grown to $90 billion and September’s volumes, albeit distorted by the calendar roll, are set to be even higher.
The CME has clearly tapped into demand for a viable exchange-traded FX product and it has also capitalized on the fact that it provides a multi-asset trading venue. "We’ve seen traders moving across into FX from equities and, in some cases, these clients are starting to look at commodities. Around 35% of our clients have traded something else before moving to FX," says Derek Samman, managing director and global head of FX products at the CME. "We provide a level playing field to all our participants – they all get equal access to each and every price in our futures market. Additionally, there are other benefits to trading on exchange from a regulatory perspective, such that all of our market participants benefit from operating in a regulated market with segregated funds, which virtually eliminates the counterparty risk. This counterparty risk mitigant is unique to the central counterparty model, which doesn’t exist in the OTC market."
The CME’s rise has also been helped by the fact that although various other exchanges offer currency futures, they have not posed any real competition. One of these is Ice Futures US, which inherited a range of FX contracts when it took over the New York Board of Trade and its Finex subsidiary in Dublin. These included the moderately successful dollar index, introduced as long ago as 1973, which trades about 20,000 contracts a day.
However, Ice is poised to launch far bigger contracts with a nominal size of 1 million units on 11 currencies plus the dollar index in November. These will be fully fungible with its existing products. The relaunch is being overseen by Ray McKenzie, the exchange’s vice-president and head of sales. McKenzie is a veteran of the FX futures market, having run one of the largest cash to futures arbitrage teams for years when he worked at Morgan Stanley. He has also worked at the CME, where he played an important role in revamping its FX business.
The CME will probably not, certainly initially, be overly concerned about the competition. After all, other exchanges have also tried to challenge its hegemony. Most recently, Eurex US also launched bigger contracts to bring it more in line with the OTC market but it failed dismally to gain any traction. This was mainly because its technology was too slow, which left its market makers exposed to latency arbitrageurs. Ice says it will not experience this problem and that its technology "features the fastest trade execution times in the futures industry today". And given Ice’s successful forays into several other established markets, the CME will be wise to be wary.
If nothing else, Ice’s move is likely to lead to fee compression. Its standard commission charge is $1.35 per side, or per million currency unit, inclusive of exchange and clearing fees. This is far cheaper than the CME’s headline rate of about $3.50 per side and below EBS’s starting tariff of $2.50 for a passive and $5.00 for an aggressive trade.
Ultimately, low fees are irrelevant if there is no liquidity. Ice says it has signed up numerous prominent and genuine market makers. Not surprisingly, McKenzie is upbeat. "Institutional traders, hedge funds, commodity trading advisers and retail traders have been seeking greater efficiencies in terms of cost, transparency and straight-through processing in the FX markets," he says. "By offering futures contracts that mirror cash market trading conventions, but with enhanced efficiency and the vital benefits of centralized clearing, Ice Futures US will bring a valuable new FX tool to market participants globally."