Emerging-market foreign exchange (EMFX) has been overlooked in the drive towards electronic trading and there is widespread demand for a greater range of trading channels, according to newly launched platform R5FX.
“There hasn’t been much attention paid to EMFX in the past,” says Jon Vollemaere, chief executive of R5FX. “It is much smaller than the spot market and operates very differently in different parts of the world.
“But as demand for EM exposure grows, and the focus shifts more and more to China, we expect these markets to become more electronic.”
|As the world rebalances, greater profits can be|
made out of EMFX than G10 currencies
R5FX has been in development for several years, but began a soft launch last month with the three aforementioned Latin American currencies, adding the Indian rupee earlier this month. It operates a central limit order book with a centralized credit model so that all participants can trade with one another.
However, it believes other markets such as Mexico, Turkey and Indonesia hold substantial promise.
“As the underlying economies grow, so too do their foreign-exchange needs,” says Vollemaere. “Some of the African and Asian currencies don’t yet have sufficient liquidity to make electronic trading worthwhile, mainly because of low investment and capital flows.
“But the Brics and several other countries represent huge opportunity.”
An area of focus for R5FX is the non-deliverable forward (NDF) market, which provides access to EM currencies that still have capital controls in place, as the trades are settled in US dollars – usually in a major trading centre – rather than being physically settled in the underlying currency.
Roughly $64 billion is traded daily in NDFs in London, according to the latest Bank of England survey conducted in April 2015. That is just over 2.5% of overall FX market turnover in the UK.
While large FX platforms, such as EBS and Thomson Reuters, might historically have focused on the much larger spot market, both also now offer NDF trading. EBS, which offers NDFs via its anonymous and disclosed services, has seen growth in recent years as it has expanded its range of currencies.
R5FX expects to compete with EBS and Thomson Reuters in the major trading hubs, while on the ground in EMs it will compete directly with voice brokers.
“The market will ultimately benefit from having a choice of venues on which to trade, and we feel we bring something new to the table,” says Vollemaere.
“Early adopters don’t pay to provide liquidity or to obtain market data, and banks have a strong say in how the service operates and how rules are enforced.”
Banks also have a choice over whether to use R5 InterBank, a disclosed bank-only liquidity pool, or R5 OpenMarket, an undisclosed pool that is open to all market participants.
Operating two pools gives banks the option of keeping clear of high-frequency alternative market makers, whose speed and trading practices have caused conflict on some FX platforms in recent years.
Meanwhile, regulation could also provide a boost for the new business. While the FX market has so far avoided mandates for clearing or platform trading under either US or European regulations, it is widely expected that FX options and NDFs will ultimately have to be centrally cleared and traded on electronic platforms.
|The future of the RMB:|
In the US, the advent of swap execution facilities (SEFs) in October 2013 forced a string of FX platform operators, including Thomson Reuters and Icap, to register as SEFs under the Dodd-Frank Act.
R5FX plans to register as an SEF in the US, even though only a small proportion of the NDF market is traded from the US.
“Regulators have kicked the can down the road on clearing of NDFs, but the spectre of regulatory change is still hanging over the industry, so by building a transparent, regulatory friendly platform at this time, we are likely to attract greater interest than we might have done in the past,” says Vollemaere.
Beyond the impact of regulation and setting operating models and rulebooks appropriately, the success of R5FX depends fundamentally on the continued growth of EM currencies. It’s a point on which Vollemaere and his team are fairly bullish.
“The Brics are the largest countries today in terms of size, population and growth – half of the world is now Indian or Chinese,” he says.
“As the world rebalances, greater profits can be made out of EMFX than G10 currencies, so there are clear opportunities here.”