Spot FX and
forwards are exempt from regulation under the Dodd-Frank Act in
the US, but FX options have been categorized as swaps under the
legislation. That means they will have to be cleared and
subject to reporting requirements, as well as trade over an
than 20 trading venues have expressed their intention to become
an SEF, progress has been hampered by the lack of headway made
Commodity Futures Trading Commission (CFTC) in ironing out
the rules for the venues.
There was a
breakthrough last week, however, as the final rules were
eventually published. One of the main developments saw a
watering down of the CFTC’s controversial initial
proposals, published in January 2011, which would have required
investors to send request for quotes (RFQ) to a minimum of five
rules reduced the required number of RFQs to two during a
one-year transition period, rising to three thereafter.
SEFs will be
allowed to start trading as soon as they receive a temporary
registration from the CFTC, and the new rules will take effect
60 days after they are published in the Federal Register.
Now that the
CFTC has provided some clarity around SEFs, swap dealers,
buy-side firms and corporations can begin the long-overdue
process of complying with the second key plank of Dodd-Frank:
central trading on a regulated exchange, says Zohar Hod,
global head of sales at SuperDerivatives, which runs an
electronic FX options platform with broker FXCM.
He says all
eyes are now on the trading platforms that have been waiting in
the wings to become registered SEFs.
been claiming they were ready for months, and now they control
their own fate, says Hod. Not all of the 20-plus SEFs will
survive. Ultimately, technology, volumes, liquidity and
connectivity will decide the outcome over the next 12 to 18
A number of
electronic multi-dealer options platforms have been
launched in recent years in anticipation of the new regulation.
In addition to SuperDerivatives’ joint venture
with FXCM, Digital Vega, Tradeweb and SurfaceExchange all claim
to have attracted support from leading liquidity providers.
larger players such as Thomson Reuters’ FXall and
Bloomberg have also entered the fray.
understandably, would prefer to keep profitable options
business on their
single-dealer platforms or trade in the traditional way
over the phone. The new regulations, however, will mean an
inevitable migration towards the multi-dealer environment and
electronic trading of FX options.
see an increased appetite from liquidity providers to connect
to the platforms and stream prices, which in turn should
promote the growth of
electronic FX option trading.
As well as
providing impetus for market incumbents, however, the
finalization of the SEF rules is also likely to attract new
entrants into the market.
Goodbody, managing director and business manager at Hotspot FX
– the multi-dealer trading spot platform that was the
most improved venue by market share in this year’s
Euromoney FX survey – says entering the FX options
business is something the firm has been considering for some
however, there was no first-mover advantage in the electronic
options trading business. Indeed, Goodbody says the legislative
environment slowed down the electronification of FX options,
with the market getting stuck in a five-year quagmire waiting
for the regulations to come in.
We have been
watching the development of the market and now that the rules
have finally been finalized, it gives us something to plan
around, he says. Now at least we know the requirements and
can evaluate a business model around them.
he would not be shocked if Hotspot FX moved into options. We
would definitely like to see our product base expand and find
more ways to interact with our clients, he says.
development of the FX options business has wider implications
for the currency market.
prospect of increased electronification of FX options,
traditionally the preserve of bigger, more sophisticated
investors, has the potential to level the playing field,
simplifying trading execution and opening up the market to
other less-savvy client segments.
That could be
welcome news for some market participants. Many believe, for
example, that customers such as corporates can increase the
efficiency of their currency trading strategies by moving away
from hedging their exposure using forwards towards using
of waiting on the launch pad, the finalization of the SEF rules
might be pushing FX options trading towards lift off.