Earlier this month, CME announced plans to launch CME FX Spot+, an all-to-all spot FX marketplace connecting cash market participants with the company’s FX futures liquidity.
Paul Houston, global head of FX products, says the new marketplace (to be made available for client testing during the second half of next year) would increase access, transparency and trading opportunities across spot FX and FX futures markets.
The all-to-all spot FX marketplace concept has been in the works for the last decade or so, and it is perhaps surprising that it has taken CME so long to come to market with a solution.
One possible answer is that despite early predictions that all-to-all would come to be the dominant trading environment, this has not turned out to be the case – or at least, not yet.
“There are suggestions that FX as an asset class has seen significant growth in on-exchange trading volumes recently and a shift away from its historical over-the-counter-heavy environment,” says David Morrison, senior market analyst at Trade Nation.
Preferences
FX trading volumes continue to grow year on year, despite a brief dip in 2015/16 linked to the Swiss National Bank’s shock decision to drop its target floor against the euro. But Morrison is not convinced that this is the beginning of the end for OTC.
“While bringing liquidity pools together sounds like a win-win, there are going to be FX participants who prefer to trade in an OTC environment,” says Morrison. “Some will welcome the standardization of contract sizes that rules-based trading venues offer, but many others will prefer the freedom that OTC trading brings.”
According to Kate Leaman, chief market analyst at AvaTrade, the new marketplace will create additional opportunities for traders to make money by taking advantage of price differences between different markets.
However, Filip Kaczmarzyk, head of trading and board member at XTB, is less convinced. He accepts that the new marketplace will improve trading and hedging opportunities but does not believe it will boost transparency due to the sophisticated nature of the product.
“The solution will be offered via CME FX Link, which will enable traders to trade the spread between two types of instruments,” says Kaczmarzyk. “This also means that the product will only be available to experienced traders. CME states that transparency will be improved, but we will only be able to see this first-hand when the final product is released.”
This integration is likely to bridge the gap between traditionally segregated markets, fostering easier interaction between cash market participants and FX futures liquidity, says Tal Dar, vice-president of institutional sales at Vantage, “but it doesn’t necessarily mean a complete departure from OTC markets.”
Use of standardized contracts traded on exchanges for instruments such as currencies and options is increasing, but private deals remain important – especially when traders need to customise their agreements.
Next step
Following its acquisition of EBS (NEX), CME has been innovating, and bridging its FX futures market and the spot FX marketplace with the introduction of its order book and branding it ‘FX Link’ was no coincidence, according to Fatih Atalay, head of eFX and FX trading at Swissquote, who describes the new marketplace as a logical next step for CME and a welcome development.
“Whether the rates market drives the spot market or the other way around is up for debate,” he says. “What holds in any case is that these two markets don’t function independently.
“If we think of them as orthogonal forces, linking them can only help to absorb the initial impact in one market better in the second one, and so contribute to smoother functioning of both markets.”
Of course, this does not mean that the FX market is inefficient. Despite its decentralized nature, the FX market is efficient thanks to a well-functioning credit and trust network of banks that build the core of the OTC spot and swap markets.
While banks have a long history of contributing to lit central limit order books of FX spot and futures, trading in the FX swaps market is still mostly over the counter.
“Central limit order books are an indispensable utility for reliable price discovery and well-functioning markets,” says Atalay. “Such primary systems are not accessible to all participants though, and some will prefer to internalise the flow instead of passing it over to a lit market.”
