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Uncleared margin rules unlikely to clarify clearing migration


Paul Golden
Published on:

FX prime brokers are expected to adapt to the pricing challenges of uncleared margin rules, but it remains far from clear whether these rules will push the market definitively in the direction of central clearing.

A report published by Citi earlier in April stated that uncleared margin rules (UMR) costs could seriously impact returns for FX prime brokers unless offset through pricing or other efficiencies.

Its analysis of UMR funding costs for a non-deliverable forward trade suggested that brokers have substantially underpriced transactions that will be in scope for the rules.

Traditionally, clients posted initial margin to FX prime brokers who, in turn, did not post initial margin to execution brokers, thereby creating a capital inflow.

After the full implementation of UMR, FX prime brokers will no longer benefit from the liquidity of client initial margin since it will need to be segregated.

'Tiered pricing'

At the same time, these brokers will be required to post and segregate initial margin to both their clients and their executing brokers for FX derivatives, which will lead to capital outflows.


Jon Vollemaere,

“We will probably see some prime brokers change their business models, maybe offering a tiered pricing plan for different products or pursuing partnerships to function as a clearing prime broker, offering services for both cleared and uncleared products,” says Jon Vollemaere, CEO of R5FX.

“Having to post margin makes the business far more capital intensive and therefore it has to change.”

Industry observers have previously questioned whether UMR will lead to central clearing becoming the prevalent credit model in FX, and the Citi report notes that clearing houses will not be capable of – or commercially interested in – clearing all FX products.

For the foreseeable future, gaps in industry infrastructure are expected to prevent the wholesale industry migration of certain physically settled products to central clearing, including FX options.

It is possible that many bilateral trades will migrate into central clearing.


Chris Perkins,

However, not all FX trades will be clearing-eligible for the foreseeable future, adds Chris Perkins, global head of FX prime brokerage and over-the-counter (OTC) clearing at Citi.

“For these transaction types, the capital and operational efficiencies delivered by FX prime brokers will be more valuable than ever and may be attractive to new client segments, including asset managers,” he says.

According to R5FX’s Vollemaere, FX is moving inexorably towards a centrally cleared model as evidenced by the number of exchanges buying OTC FX venues.

“We have been saying for years that it makes sense to use a clearer as a more efficient way of settlement and UMR will only push that further,” he says. “However, clearers need to review their pricing of FX products for the marriage to last.

“Additionally, UMR doesn’t impact spot, which seems to be working efficiently, so I don’t expect any significant changes there.”

'Separate decisions'

Andy Coyne, co-founder and chairman of Cobalt, reckons credit decisions will be initially driven by how much can be traded and access to best price, followed by a separate decision on the clearing model.


Jason Hughes,

Meanwhile, Jason Hughes, global head of sales at ADSS, is even more circumspect, suggesting that central clearing may not add to the efficiency of the interbank FX market.

Any change to the status quo will need buy-in from many participants, explains Hughes.

“We have seen a move to exchange or central-cleared models in other highly liquid OTC markets being met with a muted response from investors and market makers who prefer the traditional approach, particularly if transactional costs remain lower in the established model,” he says.

Hughes also expresses concerns about how central clearing could impact liquidity, noting that any move that essentially creates two avenues for traders or investors – such as centrally cleared versus traditional OTC – will likely have a negative impact on liquidity.

“Higher costs in any financial market, either in terms of margin or transactional fees, normally result in a reduction of volume,” he adds.

Citi’s Perkins, though, observes that other markets have managed to maintain deep liquidity under the cleared paradigm and that central clearing delivers additional benefits to clients, including strong segregation and portability, further mitigating counterparty risk.

Vollemaere concludes: “Liquidity would be impacted in the short term as prime brokers work to get pricing right and some marginal clients move away from trading FX, but the market is used to managing new regulations, and liquidity would bounce back.”