A large percentage of this growth has come from the CME Group, which first listed such contracts in 1972. Volumes have mushroomed since 2002 after the Chicago bourse began offering electronic access to algorithmic and model traders, most notably commodity trading advisers. Strong interest from Chicago traders has helped push trading to an average of $110 billion a day, according to the Bank for International Settlements, more than double the level it was before the financial crisis. So are exchanges beginning to pose a threat to the over-the-counter market, or are they a useful source of liquidity for the main market-makers?
Overall FX growth
Large FX participants in the OTC market say the growth of exchange-traded FX simply mirrors the overall growth in FX as an asset class, especially in reference to high-frequency trading. According to the BIS, HFT represents the majority of the increase in total FX volumes over the past three years, now worth $4 trillion a day. In other words, high-frequency traders are the tide that lifts all boats. According to this year’s Euromoney FX survey, total volumes outside exchanges grew by 6% over the past year.
“Exchange volumes do vary and we do use them as a liquidity source. There are times when we might do as much with CME as we would with other platforms such as Reuters, but on average our exchange-traded volumes are a lot lower than in the OTC market,” says Greg Knight, head of spot trading at Deutsche Bank in London, the world’s biggest trader of foreign exchange. “For spot and forwards, we do not believe that exchanges are likely to take off as a liquidity source. However, we are always looking for optimal liquidity, and so we are always going to use them.”
Still, some hedge funds say exchanges have other merits that make them attractive places to trade, such as the removal of counterparty risk, which might help explain some of the rising volumes since the crisis. “We moved lots of resource into exchange-traded futures in 2008,” says one head of execution at a large London-based macro hedge fund. “If credit is shaky, then it makes sense to put business through the floor, so it can be cleared.”
Drawbacks
However, exchange-traded contracts do have drawbacks when used as an OTC spot alternative, because they trade as forward contracts, and so spot traders are effectively taking interest-rate risk. Additionally, a higher cost per ticket owing to exchange membership fees and mandatory clearing may deter others.
“Many of our FX hedging customers do not typically use the listed product. It is not an appropriate tool because our clients need to hedge every day of the year and not once a month,” says the head of FX sales at one European FX bank. Nonetheless, competition for a slice of the FX wallet in the exchange world is hotting up.
The InterContinentalExchange listed a suite of euro-denominated pairings in May, with face values of €125,000 ($180,000) – identical to those at the CME. The bourse’s benchmark dollar index futures, which began trading in 1985, reported record monthly trading for May.
Leveraged fund awareness of the dollar index as a useful hedging tool in volatile markets (September 2008 was by far the busiest month on record for options on the index) has now captured the broader attention of the market, the exchange says.
And that attention is translating into real flow: if volumes for the second half of the year are annualised, 6.86 million contracts should change hands this year, worth a notional $521 billion – up 7.6% on last year, and nearly three times as much as in 2009. ICE says it hopes to compete with the CME by offering lower pricing, as well as smaller, half-tick increments. “Throughout the year, we’ll be launching more FX products to compete with other exchanges. We see FX as a big opportunity for growth,” a spokesman tells Euromoney.
Competition
However, the CME still turns over some 30 times more notional volumes than its rival across all contracts. “We believe competition makes us better,” says Roger Rutherford, global head of currency products at CME Group. “What we see from this move is that ICE’s product slate has caught up with ours. Our FX liquidity benefits from clients who are already trading in other asset classes with us.”
| Average daily FX turnover on CME and EBS ($bn notional) |
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| Sources: BIS, CME, EBS |
He gives the example of natural-gas traders simultaneously buying Canadian-dollar contracts to hedge against exchange-rate risk. Under the CME’s tiered pricing system, high-volume players pay tapered fees for their monthly trading, meaning a reduced cost per ticket for bigger-flow players. Interdealer brokers are playing a bigger part in the FX futures market too, says Rutherford, picking up on the fact that they can broker FX futures alongside their cash products – though few employ ETD-only FX brokers. Other brokers, such as Icap, are perhaps less keen to divert resource away from their own interbank pools of liquidity.