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ForewordBy Frances Faulds

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Five years since the Pittsburgh G-20 Summit where global leaders agreed upon four fundamental principles for the over-the-counter derivatives market, the derivatives industry is still digesting the raft of new regulations. While work continues on building the infrastructure needed to trade and clear interest rate swaps in standardised electronic marketplaces, attention is turning towards the growing exchange-traded FX market.

CME Group’s FX volume averaged 1.2 million contracts per day, up 39 percent from September 2013, and included a record 110,000 FX options contracts, as well as record British Pound futures and options average daily volume. The average daily notional value of FX contracts traded in September was $134 billion. In addition, FX open interest hit an all-time high of 2.6 million contracts during September prior to the quarterly expiry. Up until this year, much of the exchange-traded FX business was done on exchanges outside of Europe with the US leading the way with CME Group’s well-established FX offerings and the Indian and Russian exchanges taking the top slots in trading volumes with their smaller sized contracts. However, this has changed with the launch of CME Europe in April offering 30 FX futures contracts and the subsequent launch of Eurex’s futures and options on six of the most liquid currency pairs in July.

CME Group’s Senior Managing Director, Commodity and Options Products, Derek Sammann, says that CME Europe was set up to fill a gap in the market by providing exchange-traded FX products in Europe. CME Europe is a London-based, FCA-supervised derivatives exchange. As a wholly-owned subsidiary of

CME Group, CME Europe leverages the operations and expertise of the world’s largest derivatives marketplace and is designed to meet evolving regional needs and trading practices. CME Europe delivers connectivity and operational efficiencies to customers through proven CME Group infrastructure like CME Globex and CME ClearPort, as well as the clearing services of CME Clearing Europe, an established London-based clearing house.

Exchange-traded FX brings greater transparency to the market. Eurex now publishes live order book data for its six futures and options on its website. The products have also been designed with the OTC trader in mind, by combining best-practice OTC market conventions with the transparency of exchange-traded derivatives, while Eurex Clearing mitigates counterparty risk for each transaction until the final settlement day.

For existing members, trading FX on Eurex Exchange brings the added benefit of a “one-stop-shop” with more than 2,000 products in nine asset classes all on a single platform, enabling portfolio diversification and creates new opportunities for hedging

Although FX swaps and forwards received exemptions from trading and clearing requirements imposed

on derivatives in other asset classes, they will still be impacted by the greater capital requirements of Basel III, and this is expected to encourage a shift of some FX swaps and forwards business to futures, according to a report published by Greenwich Associates in January 2014, entitled The Futurization of FX Derivatives, as well as a share of non-deliverables forwards and FX options flow, which do come under the new trading and clearing requirements, which will make trading them will become more expensive. Going forward, Greenwich Associates believes that futures will offer a cheaper way for FX market participants to gain the exposures they need.

Greenwich Associates principal Kevin McPartland, Head of Market Structure and Technology Advisory Service and author of the report. Says: “A conservative 5% move out of OTC FX derivatives into futures would cause FX futures volume to grow by over 50%—a huge boon for futures exchanges. FX futures contracts have existed for years providing exposure similar to that offered by OTC contracts, and among the major global exchanges, FX futures liquidity has steadily grown over the past few years. Investors are already comfortable with the products and now they will have a big incentive to make much more use of futures.”

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According to the World Federation of Exchanges (WFE), derivatives trading on exchanges remained relatively stable in the first half of 2014 compared to the second half of 2013. As far as currency and commodity derivatives are concerned, the good performance of currency derivatives (+13.3%) was offset by the decrease of commodity derivatives (5.7%). Hüseyin Erkan, CEO of WFE, says: “The recent concerns have focused investor interest in markets that are transparent and regulated.”

2013 showed a clear growth trend in FX on exchanges. Currency derivatives increased in volume by 2.2%. European, African and Middle Eastern volumes were pushed up 15% mostly due to the Moscow Exchange, which made up 85% of the region’s volumes and the Americas were up 6%, mainly due to increased volume at the CME Group.

Exchange-traded FX seessteady growth

OPTIONSThe growth in options volumes was mostly driven by impressive growth from MCX-SX (+414%), now renamed the Metropolitan Stock Exchange of Indian (mSXI), and United Stock Exchange of India (+426%), enabling the United Stock Exchange of India to enter the top ten exchanges.

CME also saw a good progression of its options volumes in 2013 (+45%) although they remain small in terms of number of contracts traded. Moscow Exchange had the most impressive growth (+11% for 456 million contracts traded).

So far 2014 is already proving to be a good year for exchange-traded FX. The volume figures collated by the Futures Industry Association show that while there have been some slight shifts between the exchanges the top five look set to remain the same with the Moscow Exchange

looking like it is headed for first place this year.

This growth has been steady, brought on by the traction gained by new exchange traded FX products. In 2011, the highest growth rate across the exchanges came from currency derivatives, which saw a massive increase of 16% in traded volume.

This important growth was primarily driven by currency options traded on the National Stock Exchange of India since October 29, 2010. These contracts already represented 253 million trades in 2011. Although the growth rate of traded volumes in 2011 drops when the currency options traded in India are excluded from statistics (+6%), the number still remains significant.

However, the dominance of Indian exchanges in terms of number of contracts traded is to be seen against their limited weight in the

The most actively traded currency derivatives in the world in 2013

Source: World Federation of Exchanges

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FX on Exchanges, Year to Date to 31 August 2014

Evolution of notional outstanding amounts of on-exchange and OTC currency derivatives (billion USD)

total notional value where CME and BM&F BOVESPA represent around 90% of the total. Although CME only represents 9% of contracts

traded, if taken in terms of notional value of those contracts this increases to 73% against the 4% notional value represented by the

Indian exchanges’ 57% in total volume, showing clearly the relative size of the contracts.

OPEN INTEREST Unrelated to volume, open interest on the exchanges varies across the exchanges. Open interest refers to the total number of derivatives contracts that have not been settled in the immediately previous time period for a specific underlying security.

A large open interest indicates more activity and liquidity for the contract. Whereas both NSE India and mSXI (formerly MCX-SX) saw a spectacular decrease in open interest, relative to volumes traded, (around 70% for both exchanges whereas volumes were only slightly down), some exchanges which have a relative small weight in volumes represented large proportions of open interest.

Exchanges such as the Johannesburg Stock Exchange, the Moscow Exchange and the Rosario Futures Exchange (ROFEX) in Argentina show large open interest as these exchanges are based in countries where commodities exportation is extremely important in the economy, hence the strong need for FX hedging illustrated by the importance of open interest.

Source: BIS

David, how has the LMAX model changed and evolved to serve the needs of the market?

We learn lessons every day and it is an evolving market. The big change for us is that we have more and more focused on the institutional space over the last two years. Two thirds of our flow now comes from brokers and funds; include money managers and that would bring it to three quarters of our entire flow. The requirements of those market participants mean that we have had to alter the way we do things internally and focus on the institutional space. They need greater speed, larger order rates, a much deeper order book; they want full transparency and trade reporting. This has actually changed the staff we hire at LMAX Exchange and the skills needed. It is a much more complex selling process

nowadays. Gone are the days were you could just discuss commission and spread, the initial conversation is now ten questions deep and you’ll end up with what version of FIX is being used for the API and what the order rates are etc. This is the biggest change we have witnessed at LMAX Exchange but I think it is also the greatest opportunity.

LMAX Exchange now offers three venues: Professional, Institutional and InterBank. What has been quite surprising for us has been the interest and growth we have experienced from the Asia Pacific region. This is our fastest growing market and now represents more than 40 per cent of our total volume. As a result, we are opening a new distribution office in Hong Kong this month and a matching engine in Tokyo, due to go live at the end of this year. Building

to service this market has been unexpected; we didn’t predict this to be such a big part of our business.

Where is this growth coming from?

Funds and brokers trade on LMAX Professional venue, which is still our leading venue. Our revenues and volumes have been growing at 50 per cent half-yearly, compounded. LMAX Interbank is growing and while we are pleased with the growth, the volumes are still small, may be $1 billion a day. More importantly, there are 23 top global banks connected and another 15 are in the pipeline. Those banks trade externally over £500 billion a day. We see the interbank segment as a big growth area for us. People are looking for firm liquidity at a better price, in terms of cost of trading and cost of market data, with the pre-

LMAX Exchange offering a unique vision for FX

LMAX Exchange, an FCA regulated MTF for FX trading, offers a unique vision for global FX trading and three distinct pools of liquidity. David Mercer, CEO of the company talks to Frances Faulds.

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and post-trade transparency you get from an exchange or an MTF.

How do you see the execution model for FX trading evolving in the light of incoming regulation?

Certainly while regulation hasn’t directly affected the spot market, the rhetoric coming from the politicians is for greater transparency. The key principle of treating customers fairly, which grew up out of the retail side, applies to all customers and I think market participants are looking for greater consistency and understanding in how their orders are executed. I cannot believe that bilateral deals and dark pool venues of any sort can be the way forward. Ultimately it is about getting the best price for the customer, so if you can deliver that differently, fair enough. However, in our view the exchange model is the most efficient for trading liquid products, such as spot FX, and we have witnessed this already with other asset classes around the world. The ‘Last look’ is a difficult and sensitive issue. I can see why market makers prefer it but I don’t think any customer likes it. Also, I don’t understand why there are different prices for different users. On LMAX Exchange it is the same price whether you

want to trade $1,000 or $100 million. Obviously, the spread widens the bigger the size you trade but everyone has access to those prices. In the rest of the industry discretionary pricing means that some of the better prices are not available to certain customers; I don’t think that’s the way forward and certainly, that is not the way the regulation is pointing. Everything is pointing towards ‘lit’ venues. If they can give the customer a level of transparency of the prevailing market versus the executed market then it may work, but without that transparency it can’t be sustainable.

Do you think the FX market can achieve best execution along the same lines as the equity market or is the market still too fragmented?

The short answer is yes, but we need more published limit order books. Right now, it is available. On LMAX Exchange you can see a benchmark price or a true firm limit order for $50 million EUR/USD, available 24 hours, five and half days a week. That reference rate is available now, other venues might have benchmarks up to a few hundred million. There is a lot more available than people discuss, and I would encourage more venues and operators to go this way. While

you retain this OTC bilateral world, especially with the ability to re-quote, it is difficult to get a true benchmark. You cannot compare LMAX Exchange with a venue that has ‘last look’, as its blended price has no relevance because some of it can be re-quoted. The ability to re-quote is preventing the market from moving forward but it will happen.

What are you bringing to the interbank market and how can you compete with the incumbents?

It grew up from requests from member banks, which were pricing into the professional venue. They liked our technology, our concept and our pricing, and they were looking for an alternative. For us it was relatively easy to deliver LMAX InterBank, as it was built based on the same proven software, but simply for a different client segment. We believe LMAX Exchange can deliver a better service to our member banks. It is a competitive space and we have to deliver better pricing, faster and more robust execution than the incumbent primary markets. However, this shouldn’t be that difficult for any new player. Ultimately those banks will vote with their price streams. So far, we are very happy with our progress. Banks signed today trade more than 25 per

cent of the total spot market, and it’s pretty obvious, once they are aware, that they can get their orders done quicker and at a better price.

Do you think there is a greater blurring of lines between the ‘buy-side’ and the ‘sell-side’?

Yes, I’m not even sure that terminology is relevant any more. Traditionally, funds were takers and the banks were makers. However, today a lot of the leading proprietary firms, or High Frequency Traders, are amongst the most significant market makers in the marketplace and likewise, you see a lot of banks taking, or aggregating, a lot of the HFT market making prices. There are venues all around the world, where banks are going to be taking from HFT market makers or vice versa. There is a natural blurring and it should be a good thing for all participants. No matter who you are, or how we classify you, everyone just wants to trade at the best price they can. As a result, their industry classification and counterparty are irrelevant. If the credit and clearing options are available, there is less concern about being the maker or the taker.

Are you taking still more steps to lower latency and do you think the FX as a whole is addressing properly?

Lowering latency is an on-going process for us. With more participants connecting to LMAX Exchange all the time, there is more demand on order rates. To retain and enhance our speed advantage LMAX Exchange has a dedicated performance and capacity team, comprised of low latency developers and financial infrastructure experts. Our short-term target is to process 100,000 orders per second for a sustained period.

Throughout the industry everyone is aware of latency and they are

investing in it. Certainly, all our market makers are addressing it, and quite a few of our market makers have used part of our Open Source technology, Disruptor, to enhance their own message rates and trading algorithms. I would be critical of other venues which haven’t invested in technology and persist with flawed methodologies, such as ‘last look’ and randomisation, to cover the cracks in their creaking legacy systems. It is key to enable market makers to make precise prices at all times and give their liquidity providers streaming market data, not snapshots ten times per second.

Investing in technology is important, so that a maker can price accurately all the time, and not have stale orders swept. This is not going to go away, things will get quicker as computing power increases and everyone has to keep investing in it.

Are there any incoming regulations that will affect your users?

Not really. In many ways we already provide what the regulators require. One change that happened this year is the central trade reporting; so we provide it, at our own cost, to the customers who need a Legal Entity Indicator. The regulators are asking for transparency, which we offer by publishing every trade and our order rates. Further down the road, there might be greater netting required across products and asset classes. If this is the case, then an MTF with the ability to centrally clear, will be beneficial to customers. As a result, we are talking to them now about what their large exposure requirements might be and what netting benefits could be provided by trading assets on an exchange, being able to net forwards with spot, or even other asset classes with FX products, provided they are centrally cleared. Capital efficiency could be a leading a driver in the years ahead for market participants, as there are more and more requirements on their balance sheets.

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The regulatory push to get as much of the standardised OTC business as possible onto electronic trading platforms or at least cleared through CCPs is having a tremendous impact on the world’s derivatives exchanges. Already this year, two exchanges have launched new currency contracts in Europe. In July, Eurex began trading currency futures and options contracts for the first time following hot on the heels of the launch of CME Europe, a wholly new exchange for Europe which opened its doors in London on 28 April with 30 FX futures products.

Derek Sammann, Senior Managing Director for FX, Metals and Options, at CME Group and board member of CME Europe, says CME’s European launch was prompted by the belief that FX was an underserved market in Europe and that although it has a well-oiled machine on the OTC side, there was little in terms of exchange traded listed products.

He says: “When customers are looking at increasing demands and changes as a result of, not just US regulations around Dodd-Frank or European regulations around

EMIR, but also BCBS/ISCO rules that are going to be changing the regulatory capital requirements for OTC bilateral trading. This is a change that is going to unfold in the global FX market. When European customers look at how these capital charges are going to impact their businesses they are going to have to find the most cost effective and capital efficient way to continue to trade in the FX market.”

“It is a different set of challenges when you are talking about a global market and where you are starting to see a balkanisation of regulations. This is why we wanted to bring exchange-traded foreign exchange to the European marketplace. It was underserved and we decided we needed to globalise our infrastructure and provide those attendant benefits to non-US customers should they wish to choose our European regulated entity to do their business,” he adds.

Sammann believes the regulatory landscape has still a long way to go in unfolding. The impact on market structure of the new capital charges is already putting the bilateral credit model under threat.

CME Europe went live with FX futures and a small suite of bio-fuel products. Sammann says that the

Connectivity, clearing and contracts –wider opportunities for currency trading on exchanges

With mandatory central clearing for FX OTC products already prompting a greater number of clearing services, contracts and connectivity options being offered by the exchanges Frances Faulds looks at growth in exchange-traded FX.

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“We absolutely believe that over time exchange-traded FX will continue to play a larger and larger role in the global FX market.”

Derek Sammann

main focus of the launch was FX. This was in order to make the same products available to European customers as global participants are already trading in the US, at CME Group. “The European client-base is now seeing the impact of MiFID, Basel III, BCBS/ISOCO and EMIR and they need to make changes to their business model. When you look at the global FX marketplace, it is massive market that has got to go through a huge amount changes. When we announced this in August 2012, there was no European platform providing on-exchange trading for FX in Europe. We have the global leadership position in our US franchise and we wanted to be able to serve an underserved market in foreign exchange,” he says.However, Sammann welcomes the Eurex launch in July as being good for the market because customer choice is paramount. He believes it increases customer focus on the benefits of on-exchange trading, provides customers with an increased set of connectivity options, and it is raising awareness of the capital and operational efficiencies of a centralised exchange-traded FX marketplace. He adds: “Over the last ten years we have proven that

on-exchange trading in foreign exchange is real. We have invested in our client base, our product sets, building our options business, building our infrastructure with our clearing house and now a European exchange. We absolutely believe that over time exchange-traded FX will continue to play a larger and larger role in the global FX market, so others following our lead are validating our business model and what our customers have told us.”

CME allows customers to choose between physically settled, an exchange of two principle amounts through CLS, and cash settled FX, where deliverable currencies are converted and not physically exchanged, just the difference in P&L, and this is the same in the European exchange.

MULTI-ASSET EXCHANGEOther products will be announced in due course but Sammann can confirm that CME Europe is not going to be an FX-only exchange and it is looking at certain fixed income products to complement its swaps clearing capability in Europe. He says: “It makes more sense in capital intensive businesses

David Holcombe

“We will look back on 2015 as the year exchange traded FX really took off.”

NASDAQ FX Option Volume

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like trading for CME Europe to be multi-asset class to achieve the same success in our US exchanges. The benefits of multi-asset exchanges are significant in terms of capital efficiencies for the customer. To ensure we can provide our customers with the most capital efficient model we are aligning the OTC products that we clear with the exchange-traded products that we trade on our exchange. By having those in the same European clearing house, over time we can provide margin offsets as we do in the US

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Connectivity, clearing and contracts

with our OTC swaps clearing against Treasury futures, for example.”

Sammann says CME Europe will continue to add currency pairs as well as FX options on the foreign exchange side. “A large number of European customers are already trading in our US markets and have already been able to access the cross-margining benefits of our US business, mostly on the fixed income side. We are working to be able to provide portfolio margining as quickly as we can in our European clearing house and exchange. We have found in our US franchise that the portfolio margining benefits are significant.”

EQUITY AND RETAIL PARTICIPANTSNasdaq OMX offers a total of US dollar-settled options on seven major world currencies as part of its PHLX World Currency Options. The cash-settled (USD) securities options on FX, launched in 2006, marked the first time retail investors were provided the ability to hedge or trade the direction of major currencies utilising options trading strategies paralleled to equities.

Phil Harris, Head of FX Strategy at Nasdaq OMX says: “We believe strongly in the increased participation and overall growth of the FX market, including the use of FX options. Specifically I would highlight our engagement with retail participants. Our seven FX options contracts are tailored for equity options participants who want to express a macro position via a currency – these are under the SEC and are not impacted by Dodd Frank. They behave like an index, but track the underlying spot FX prices in increments of 10,000 units of currency. We are encouraged by the recent uptick in our ADV and the increasing level of interest shown in this product due to investments in education despite record levels of low volatility.”

LMAX Exchange:Spotting the differenceServicing brokers, funds, corporates, asset managers and banks, LMAX Exchange is an FCA regulated MTF (Multilateral Trading Facility) for FX trading. LMAX Exchange delivers a unique vision for global FX trading providing a transparent, neutral, level playing field for all market participants, regardless of status, size or activity levels.

The LMAX Exchange OPEN order book is driven by streaming, non ‘last look’ limit orders supplied by General Member liquidity providers. Re-launched in 2011, offering a range of key products, including spot FX, precious metals, commodities and equity indices - LMAX Exchange guarantees complete pre/post-trade transparency and strict price/time priority order execution (where no ‘last look’ is standard) at an average speed of 4ms. David Mercer, CEO of LMAX Exchange, says: “We are very happy to be aligned with derivatives exchanges. The MTF principle of an open order book, whether it is trading FX, derivatives or equities, is one that we fully adhere to. Whether for derivatives or FX, the MTF model delivers traders the quality and consistency of firm, limit order execution.”

However, the key difference between LMAX Exchange and derivatives exchanges offering FX instruments is that LMAX Exchange operates in the spot market rather than the derivatives market. Says Mercer: “The greatest liquidity in the FX market is in the spot market and no matter how much volume there is in short-dated futures, it is dwarfed by the spot market. We are squarely in the spot market, with deeper liquidity, but offering the same quality of execution that you expect on exchange.”

With the regulators pushing hard against the OTC market in favour of more transparent market places, LMAX Exchange offers a timely alternative in the spot market to single bank portals and dark pools by bringing the same features of exchange trading to spot traders. Says Mercer: “Obviously we believe this method of execution is preferable to the end-user and it is what should be expected. I don’t think there is any place anymore for bilateral deals and the ability to ‘last look’, reject or re-quote an order.”

However, he adds that while he believes an open order book is the way forward, FX is a massive asset class and the industry is perhaps still a long way away from having one central limit order book similar to the equities market and now in futures exchanges, but Mercer firmly believes that the MTF model for FX is a step in the right direction and says that he is happy to lead that way with LMAX Exchange.

David Mercer

Nasdaq OMX’s European CCP is focused on ensuring its members are able to clear all mandated-to-clear FX products with Nasdaq OMX. For this reason, as well as providing NDFs, Nasdaq OMX is participating in the GFMA GFXD CCP group, which is working through the challenges the industry faces in order to satisfy an expected clearing mandate for OTC FX options.

Further to this, the exchange is broadening its FX product set to meet the changing demands of the FX market in the light of the new regulatory clearing requirements.David Holcombe, Head of FX Product, at Nasdaq OMX adds: “We have the broadest scope of FX products in the CCP landscape, not only services addressing mandated clearing, but also a toolkit of non-mandated products for members to establish new client offerings; targeting the obvious benefits of CCP clearing such as reduced capital charges, and also clearing specific areas of FX business in order to minimise utilisation of scarce credit lines.”

“While a FX clearing mandate will of course be a catalyst to large scale FX clearing, we are increasingly engaging with more astute market participants already looking beyond the mandate for new FX business opportunities and revenue streams,” he says.

Nasdaq OMX recently tied up with middleware vendors, Traiana and MarkitSERV, to make connectivity easier for both existing and new clearing customers to clear FX at the exchange. Says Holcombe: “Not only do we have an easy-lift membership process for existing clearing members so they can also clear FX with us, but we have been steered and supported by members who have already established a workflow with Traiana or MarkitSERV, as their approach is to route OTC trades using these industry-standard infrastructures,

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rather than having to code to a new API for each CCP they need.”

NEW BUSINESS MODELSFor Holcombe, the FX industry is still in transition, evolving to cope with mandated changes affecting pre-trade, post-trade, and execution itself. “Even without all regulation being in place, a significant section of the market is already establishing new business models to secure new revenue opportunities in FX – they are now making their ‘land grab’ in the future-state FX landscape,” he adds.

But, he says, exchange-traded and CCP-cleared FX bring obvious benefits to market participants looking for regulatory-certainty on product and execution venue, and where an agency model secures revenue without taking the risk position or assuming the credit and capital cost burden of maintaining a bilateral OTC position with that counterpart.

Holcombe believes that because the move to agency is a very difficult transition currently, especially as incumbent FX exchange venues are constrained to old-school listed FX products that do not offer

Ian Wright

“The objective is to offer a platform for offshore trading of emerging market currency contracts as DGCX offers a safe and regulated environment for international investors to hedge their exposures in emerging market currencies offshore.”

the flexibility that OTC products intrinsically offer, banks are already looking at how best to offer exchange-traded FX via their single dealer platforms and algorithmic offerings to give the customer a choice of execution venue.However, he believes exchange-traded FX will not be the ‘one-size-fits-all’ endgame for the FX market. The drivers to clear and the increasing challenges of retaining a pure principal to principal OTC FX franchise are already playing out.

right time . right place

Dubai Gold& Commodities Exchange

DGCX

Precious Metals, Base Metals, Currencies, Energy, Equity Indices & Soft Commodities.

More than 40 million contracts since inception.

Ideal geographic location - trading hours 7:00 am to 11:30 pm UAE.

Time zone overlaps Asia and Europe to the US trading hours.

Tax free environment.

Self-Regulated Organization under SCA, an a�liate member of IOSCO.

Competitive transaction fee structure with attractive incentive programs.

Tel: +971 (0)4 361 16 16 l Email: info@dgcx.ae l www.dgcx.ae

Reference herein to “DGCX” shall mean the Dubai Gold & Commodities Exchange DMCC. This publication is for information only and does not constitute an o�er, solicitation or recommendation to acquire or dispose of any investment or to engage in any other transaction. Neither DGCX nor its a�liates, associates, representatives, directors or employees, shall be responsible for any loss or damage that may arise to any person due to any action taken on the basis of this publication. DGCX shall not be responsible for any errors or omissions contained in this publication. All information, descriptions, examples and calculations contained in this publication are for guidance purposes only and should not be treated as definitive. No part of this publication may be redistributed or reproduced without written permission from DGCX. Those wishing either to trade futures and options contracts on DGCX, or to o�er and sell them to others should establish their regulatory position before doing so. DGCX is regulated by the Emirates Securities and Commodities Authority (ESCA). ESCA is a member of the International Organisation of Securities Commissions (IOSCO).

MARKET SECURITY & CAPITAL EFFICIENCYSpice up you product portfolio!Trade the Indian rupee futures and options contracts and the G6 currenecy pairs on the global commodities and currencies marketplace.

The DGCX Indian Rupee futures contract trades 40% of the the total value of Indian Rupee futures traded globally.

Trading on DGCX means that all trades are transacted and cleared within the secure regulatory framework and advantageous tax environment of the United Arab Emirates. Counterparty credit risk is managed and settlement is guaranteed via the DubaiCommodities Clearing Corporation.

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“With product innovation to bring the flexibility and scope of OTC into the exchange-traded/CCP-cleared space, gaining the benefits those highly regulated venues bring, and an acceptance that the agency model is at least a component part of an overall bank relationship, we will look back on 2015 as the year exchange traded FX really took off,” Holcombe says.

At the Dubai Gold and Commodities Exchange meanwhile, while there was a slight decline in the currencies volume year-to-date its Indian Rupee futures showed a growth of 22 per cent month-on-month in July, while Mini Indian Rupee futures rose 3 per cent.

CURRENCY AS AN ASSET CLASSIan Wright, Chief Business Officer, at DGCX says: “In comparison to the global flows, regional currency trading is still at a low level but it is on the rise. The key factors that

are driving the currency growth in the region include the growing attractiveness of currencies as an alternative asset class, the fact that UAE is emerging as a centre for forex trading, and the stronger regulatory environment, which offers participants the opportunity to trade directly in a transparent, secure and regulated environment with full-fledged clearing facilities.”

The Mini Indian Rupee futures contract has been designed to meet increasing demand from market participants for a smaller product and it allows them to use it as a hedging and investment tool without making high capital commitments. The contract particularly benefits individuals and businesses that regularly remit funds to India, and SME traders who import from and export to India.

Says Wright: “Those who trade the main DGCX Indian Rupee contract

are also able to leverage the smaller size of the contract to easily scale up or down their Indian Rupee trading volumes - in response to price-sensitive market and policy changes. Participants can construct precisely tailored hedges on the Indian Rupee. The Mini Indian Rupee Futures can be cross-margined with the regular DGCX Indian Rupee product offering, which means that any excess margin in an account for one of the Indian Rupee products can be used to cover an account in the other Indian Rupee product that has fallen below the margin requirement. Other cross-margining commodities also are being developed.”

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Eurex Exchange went live on July 7 with FX futures and options that combine best-practice OTC market conventions with the transparency and minimised risk of exchange-traded and centrally cleared contracts.

Reny Morsch, Sales, Senior Vice President at Eurex, says that the derivatives exchange was prompted to develop FX futures and options contracts due to demand from its existing member base. European customers wanted to be able to trade FX on Eurex Exchange alongside other products with the exchange. Morsch says: “We had a prolonged consultation phase in which we discussed what these products should look like with both our members and buy-side customers. We wanted to create contracts that were useful to the market and not simply copy and paste other products that were available. We wanted to deliver something unique and develop new ways of helping firms conduct their business in this market.”

CONTRACTS ON OFFEREurex has initially launched six currency pairs on four major currencies (Euro, US dollar, British sterling and Swiss Franc), choosing the exact contracts that make up the lion’s share of trading in the OTC market. More currencies will follow depending on customer demand and the exchange is looking at NDFs and emerging market currencies.

The contracts have been designed specifically for spot traders and mimic OTC terms as far as possible rather than the inverse rate normally listed on derivatives exchanges. “We wanted to make it very easy for existing OTC business to move over to the exchange by building up on existing OTC standards,” Morsch adds.

Eurex has launched with a harmonised contract size, this is 100,000 of the base currency, across all currency pairs and not fully adopted decimalisation to offer half pip quotes. This memorable contract size is small enough to offer a relatively precise hedge as well as enabling a portfolio-based approach to hedging. Standard OTC forward expiry dates are also reflected in the exchange-traded contracts, so that the full month can be traded rather than the fixed expiry dates usually found in exchange-trading.

She adds: “Here again, is a feature that almost everyone told us they wanted – a physically settled contract, with settlement in CLS alongside all their OTC business.”

ADDED PROTECTIONAnother unique feature is that Eurex Clearing remains counterparty to the trade until the trade is settled in CLS, providing full counterparty risk protection as there is no splitting of the trades into bilateral trades after expiry. Eurex Clearing stays the counterparty throughout the life of the trade until it is settled providing a solution for customers looking to diversify their counterparty risk.

Eurex has also listed options on spot, which is also a unique feature as normally options are only listed on futures on derivatives exchanges. “It is a lot easier for them to use such an instrument because they do not need to worry about delivery of the future on expiry when they exercise an option as they get the currency payment they need,” she adds. Strike price intervals of 50 pips are being offered as standard but Morsch says that strike prices in between these intervals can be set-up for customers.

The DGCX Indian Rupee options contract was temporarily suspended in 2012 to facilitate migration to a new trading

infrastructure. With the new technology platform in place, the exchange is able to support high

volumes in innovative products such

as the Indian Rupee options

contract. DGCX is

the only exchange outside India to offer trading

in both futures and options in the Indian Rupee. “Rupee options contracts launched by Indian exchanges have proven to be highly successful, which augurs well for the success of our contract. The contract will build on the success of DGCX’s Indian product offering, which has seen significant growth in

trading over the past year,” Wright adds. Since the relisting on July 18, the DGCX Indian Rupee options traded 2,300 contracts in its first month.

OFFSHORE TRADINGAs an exchange, DGCX’s product strategy aims to deliver products that compliment the INR, such as other EM currencies or Indian centric products, and products that enhance business and trade in and through Dubai, such as gold and plastics. In keeping with this strategy, Wright says the exchange places great emphasis on what the market needs and structures its products based on constant feedback from its broker members and market participants. In response to its member and market needs, DGCX is focused on developing a strong offshore platform for the trading of a range of emerging markets products. DGCX’s emerging markets currency contracts, like Indian Rupee futures,

allow international investors to hedge their exposures offshore in a safe and regulated environment. Wright adds: “These contracts are attracting increasing attention from both retail and international institutional participants, ranging from multinational banks, non-deliverable forward (NDF) markets, traders and other business entities, and have contributed significantly to the growth of the exchange’s member base.”

Wright also believes that the increasing trade between India and the Middle East is also a key factor behind the remarkable growth in the contract’s volumes. So far this year, the DGCX Indian Rupee futures contract increased its share of the total value of Indian Rupee futures traded globally to 40 per cent of on-exchange business. In July, DGCX Indian Rupee futures recorded the highest ever average daily open interest of 43,929 contracts.

She says: “We have had a lot of interest in our FX options because they are on spot. This is also attractive for banks as a hedging instrument as well as providing a new market instrument for them.” Eurex is also offering Exchange for Physicals instruments that enable trades in the spot market to be transferred into an exchange contract.

Morsch believes that exchange-traded contracts will be used more and more due to the regulatory changes and because cross-margining, both with other asset classes as well as between listed and OTC instruments, will mean customers will significantly benefit in terms of cost reduction.

Eurex: Combining the best of both worlds

Reny Morsch

As part of the expansion of DGCX’s Emerging Market currency portfolio the exchange is considering listing three new currency futures including South African Rand, Russian Rouble and the Korean Won. DGCX also plans to add the MSCI India Index futures to its equity suite in Q4.

Wright believes that FX trading is emerging as an attractive investment option in the Middle East. Market participants now have a better understanding of trading strategies, the FX market and more sophisticated technology. He says: “Tapping this growing demand and further building on the success of our currency portfolio, we are exploring the introduction of new futures contracts in emerging market currencies. The objective is to offer a platform for offshore trading of emerging market currency contracts as DGCX offers a safe and regulated environment for international investors to hedge their exposures in emerging market currencies offshore.”

PRICE DISCOVERYToday, Singapore is Asia’s largest

FX trading centre, and a leading price discovery centre for many Asian currencies. As the leading Asian gateway, the Singapore Exchange (SGX) is the most liquid and biggest offshore market for key Asian equity derivatives, and the preferred price discovery centre for key commodities such as natural rubber and seaborne iron ore. The emergence of Asian currencies, Singapore’s well-placed time zone and its USD$2.4 trillion of assets under management are key drivers in forging future volume growth.

Michael Syn, Head of Derivatives and Executive Vice President, at the Singapore Exchange, says: “FX, as an asset class, is highly complementary to SGX’s equities and commodities franchise, and we believe this confluence of liquidity across different major asset classes on a single market platform gives SGX a strategic edge to become a price discovery centre for Asian FX.”

Syn says that though they are still in early stages of liquidity growth, SGX FX futures have been very well-received by market participants, with

more than US$6 billion in notional value traded since the launch in November 2013. In particular, the SGX INR/USD futures has achieved new record volumes in recent months, with over US$1.6 billion in notional value traded during the month of August 2014 and a peak single-day record of US$350 million in notional value traded on 21 August 2014.

SGX has a dominant base for managing equity risk premium in its clearing house and it offers margin efficiencies between regional forex and Asian regional equities. Cross-margining is made possible wherever stable and significant correlations are available, including those between futures and OTC cleared products on related underlying. “For SGX, the unique risk adjacency is between currencies and Asian equities, with margin efficiencies arising from the strong coupling between currency risk premium and equity risk premium,” says Syn.

SGX is expanding its current suite of Asian FX futures with new currency futures contracts on the Chinese renminbi, Thai baht and Japanese yen in the coming few months.

Syn believes that futures have been the most preferred format to provide portfolio margining efficiencies. SGX FX futures products are designed to provide a complementary and cleared solution to OTC market participants. In catering to finer hedging requirements, the contract sizes of SGX’s FX futures are designed to be smaller compared to OTC trade sizes. He says: “Our market participants have been able to benefit from highly competitive bid-ask spreads as we have also put in finer price increments/tick sizes in our FX products. A good example is the SGX INR/USD contract which has consistently shown a very tight bid-ask spread of 0.6 to 1.2 bps, as compared to the 3 to 4 bps spreads

Connectivity, clearing and contracts

FX

ON

EX

CH

AN

GES

FX ON EXCHANGES

seen in equivalent rupee NDFs traded in the OTC market. SGX FX futures contracts are designed to be net-settled, which in our view, remove risks associated with gross settlement and closely mirrors existing settlement practices in the OTC NDF market.”

Syn believes that regulations, such as Basel III and Dodd Frank, have led investors to re-think their counterparty risks associated with unregulated OTC trades and operational and capital efficiencies in the way they conduct their FX business. As exchange-traded products promote greater price transparency through a central limit order book accessible by all market participants this has greatly benefited end users such as asset managers, hedge funds and corporates which are now seeing an increasing to fulfil best-execution requirements.

He adds: “For fiduciary managers and corporate treasurers, trading and clearing on a trusted and well-capitalised exchange have proven to support them in overcoming challenges of counterparty risks. SGX is also seeing corporates, particularly small and mid-size firms, choosing to hedge their foreign currency risks using futures due to the finer trade sizes and tighter price spreads offered on NDF futures. The upcoming clearing mandates and higher capital charges to be imposed on uncleared exposures could drive more participation on exchanges for FX transactions in the near future.”

NDF CLEARINGAs the world’s first central counterparty to clear Asian NDFs, SGX has seen clearing on a voluntary basis already begin in the region’s actively traded currencies. Syn says: “Though clearing of NDFs has yet to be mandated in any jurisdiction, interest at SGX has been healthy amidst the evolving regulatory frameworks in the major

centres and in Asia. With our recent service expansion to cater for client clearing, we at SGX are confident of positive developments in the clearing front as clients in the marketplace gain greater awareness of the benefits of clearing. Forthcoming mandates expected in NDFs can further propel this too. We will continue to engage our global market participants to explore solutions and services that will meet their evolving needs.”

Clients can easily connect to SGX through widely-used industry platforms so that it is a seamless process from execution of trade to an electronic trade affirmation and onward to SGX for clearing. To facilitate greater efficiency, SGX has a dedicated API to enable market participants that are using multiple channels and platforms to route their OTC NDF trades to SGX for clearing.

‘FUTURISATION’ OF FX While trading in exchange-traded FX products has jumped by tenfold in the past 10 years, with about US$160 billion in average daily turnover by the end of 2013 this still represents less than 5 per cent of total FX volumes traded globally. For this reason, Syn believes that there is a lot of potential for further growth in the ‘futurisation’ of FX, particularly in Asia where this growth will likely be driven by a combination of changes in market microstructure and upcoming regulatory mandates.

He adds: “For some Asian currencies, this ‘futurisation’ is already in evidence. One such example, where futures have been swiftly adopted is the Indian rupee, which is already being actively traded across a

number of exchanges (both onshore and offshore) with US$2-3 billion traded each day.”

Looking ahead, as regulatory mandates in US and EU begin to take effect for non-deliverable currencies (of which a number are Asian currencies), market expectations are that these clearing requirements are likely to increase the overall costs of trading non-deliverable currencies on OTC basis.

“In this respect, futures may offer a cheaper way for some clients to gain the exposures they need. Nonetheless, some customers will still have certain bespoke requirements for which they will continue using the OTC market. As cross-border investment and trade flows between Asia and other geographies continue to increase, FX transactions in Asia will grow in tandem as well, likely benefitting both FX exchanges and OTC markets in Asia,” concludes Syn.

Michael Syn

“For SGX, the unique risk adjacency is between currencies and Asian equities, with margin efficiencies arising from the strong coupling between currency risk premium and equity risk premium.”