R5FX is developing a central credit and clearing (C3) model, supporting all-to-all trading in both over-the-counter (OTC) and exchange flows, thereby bringing spot and NDF trades under the same umbrella.
The offering, if approved, is slated for launch in Q1 next year as part of the Financial Conduct Authority’s (FCA) regulatory sandbox programme. It enables clearing and netting functionality, and gives clients choice regarding what liquidity sources they access and how specific trades are routed post-trade.
R5FX’s C3 also offers users prime clearing, which allows them to trade with counterparties they don’t have direct credit with, while also having the trade cleared via the prime.
“That really opens up the emerging market (EM) market as participants can now trade freely with each other and lower risk at the same time,” says Jon Vollemaere, CEO of R5FX. “To date, the need for C3 has been greatest in EMs, which often have relatively small and illiquid trading pools.”
Providing access to clearing and settlement services for NDFs and other EM FX products will provide increased credit efficiency, he adds.
The move comes as volumes of cleared NDFs continues to grow. JPMorgan recently cleared its first NDF trades – involving dollars and Brazilian real – with LCH ForexClear on behalf of non-member clients since the introduction of uncleared margin rules.
That contributed to LCH posting a new monthly record for cleared NDFs in August, with $1 trillion of notional – comprising more than 130,000 trades – passing through the clearing house. The August total represented an increase of 8% from the previous monthly record, set in March.
Paddy Boyle, global head of ForexClear at LCH, says: “LCH continues to see record volumes growth at ForexClear, as the introduction of the uncleared margin rules continue to drive material demand for clearing across dealers and end-users.”
These rules mean clearing NDFs delivers considerable margin, capital, risk and operational benefits to traders.
Nick Rustad, head of global clearing JPMorgan, says the bank’s move allows for “automation of flow, which is key to our non-member clients. It enables us to provide clients greater transparency of the clearing status of their trades from execution to settlement.”
JPMorgan was already offering OTC clearing for a number of interest-rate and credit products, but has now added NDFs to the suite, in response to new variation margin rules, which impose punitive costs on trades that are not cleared.
Upcoming Mifid II (Markets in Financial Instruments Directive II) clearing straight-through-processing requirements add to the incentive for traders to clear OTC trades where possible.
The benefits are most pronounced in the longer-dated trades with durations of more than 30 days, or the larger ones, where clearing the trade markedly reduces its credit consumption under Mifid and BCBS (Basel Committee on Banking Supervision) 270, the Basel III leverage ratio and disclosure framework.
“To be fair, these benefits are bigger in clearing of swaps and options, but the principle is the same,” says R5FX’s Vollemaere.
The fact that investors are putting some of their trades through clearing houses is encouraging many to push the majority or even all of their trades through the same process, even if the capital benefits are more modest.
“The benefit is that they adopt just one process, and maximize margin offsets in the process, potentially reducing the cost of credit,” explains Vollemaere.
JPMorgan has been clearing its own NDF trades for some time, but is now offering the service to clients.
Rustad says: “When it comes to clearing, the interdealer community generally moves first and then clients follow once they see that the liquidity has moved.
“We have seen the interdealer community increasingly clearing NDFs in recent months, so I expect client demand to pick up gradually from here, though there is unlikely to be a big bang of sudden demand.”
NDFs remain a niche product, partly because they typically involve EM currencies, but while clearing NDFs might not encourage a new group of investors to trade them, it might attract some investors at the margins, says Rustad.
“It absolutely won’t put people off, either,” he says. “The fact there is an additional clearing fee could make it slightly more expensive in the short term, but for those regularly trading NDFs there could also be margin benefits that make it cheaper to trade them in the longer term.”
While there has been significant pushback from the industry on a number of regulations that have come about since the financial crisis in 2008, such as heavy-handed Dodd-Frank rules in the US, it is telling that there has been little resistance to the drive to clear OTC trades.
This can be interpreted as tacit acknowledgement that clearing OTC trades reduces systemic risk and has not been unnecessarily burdensome for financial institutions.