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Could be a great 2014 for CME Group, if a Greenwich Associates study is right
According to a research paper by US strategic financial consulting firm Greenwich Associates, we are in for some changes to the structure which comprises the bulk of the foreign exchange market. Trading activity will shift to the futures markets and away from options and NDFs (non-deliverable forwards) as new regulatory scrutiny around the globe ensures that investors reassess their ways to access the FX market, while dealers will start looking for ways to facilitate trading and remain profitable.
The report is titled “The Futurization of FX Derivatives”, and can be obtained from Greenwich Associates website. A brief summary has been released to the press and we will take note of a couple of points that the consulting firm makes.
According to Greenwich principal Kevin McPartland – an ex-Blackrock executive and an experienced capital markets professional, a rather small shift of 5% out of OTC forex derivatives into futures would cause futures volumes to rise by more than 50%. This could be a big change for the market’s structure and leading liquidity providers – the CME Group could be the biggest beneficiary should this change starts happening in the near future.
The report outlines three main pillars that sport for the coming FX futures victory. The first one is that while FX swaps and forwards have been exempted from trading an clearing requirements imposed by new regulations they are still facing more stringent reporting requirements, anti-evasion authority and last but not least Basel III capital requirements.
The second pillar is that NDFs and FX options have come under scrutiny within the new regulatory environment because of the high margin level that they carry along. Leverage is one of the biggest enemies for regulators (and for traders for that matter) since the eruption of the financial crisis back in 2008, so once tougher leverage requirements set in clients will start looking for some cheaper ways of trading.
We can argue a little on this latter point, since we have consistently observed huge Japanese FX brokerages like GMO Click post higher and higher volumes despite the toughening of margin requirements for Japanese FX accounts. 2013 has been the best year by far for GMO but to be fair the excessive volatility that has been unleashed in the Japanese FX market did contribute the most.
The third point that the report outlines is in relation to the pricing pressures that new regulatory changes will have on existing FX derivatives. NDFs and options are becoming more expensive, while the cost of futures will remain constant which will quickly make financial users migrate some orders to the less expensive futures market.
For access to the full report visit the website of Greenwich Associates.