This article assesses how buyside firms can use CME Group’s cleared FX products to manage the implications of being caught by Uncleared Margin Rules, now that the AANA calculation assessment window for this year has closed.

Top Line

The annual AANA (Average Aggregate Notional Amount) calculation window has closed for another year. However, this year many users of non-cleared OTC derivatives may find themselves newly in scope for more onerous margining requirements.

The window, which closed at the end of May, was the first step in determining whether a firm is in scope for UMR (Uncleared Margin Rules). Now, anyone with more than $8B (€8B for European firms) total gross notional of uncleared derivatives, including those held by a Prime Broker, will find themselves in scope for Phase 6 of UMR this September.

If caught, can still mitigate

Uncleared FX forwards, NDFs, swaps, and options all count towards the AANA threshold. In contrast, FX futures and options contracts listed on the CME are exempt by virtue of being centrally cleared instruments.

In other words, moving exposure from OTC FX to listed FX is a straightforward and a cost-efficient method to reduce uncleared notional and potentially avoid being caught above the threshold.

Which is all well and good for when the AANA calculation window reopens next year. But what can be done now if your firm is one of the estimated 1,100 additional firms1 caught above the threshold this year?

For starters, don’t panic.

Follow the trend, shift to exempt and more margin efficient FX products

A record2 number of your peers are using and holding large positions in CME FX futures and options, not only to reduce their gross AANA notional, but also because of the potential margining benefits they bring to those captured. CME FX futures and options present a viable and liquid alternative to uncleared FX positions, and unlike traditional OTC clearing, they are not concentrated in periphery NDF currencies.

Independent analysis by OpenGamma3 shows that a portfolio of CME FX futures and options could be up to 86 percent more margin efficient than the equivalent OTC portfolio. FX futures and options traded at the CME may also bring cross-asset margining benefits to positions held in Rates and Equities4, on top of the efficiencies described in the OpenGamma analysis.

CME Group’s Commitment of Traders tool5 – which visualises CFTC data to determine the number of large open positions in any ecosystem within listed derivatives – demonstrates that, as of May 2022, Asset Managers make up approximately 44 percent of large open interest holders in EUR/USD futures, Hedge Funds 15 percent, and Dealers 26 percent. Coupled with the fact that over $80B of FX futures and options trade every day (meaning over $160B clears, as both sides of the trade are cleared), and that open interest is near all-time highs, suggests that not only are more participants choosing this route, but from a diverse range of market participants, too.

Follow the trend, experience the flexibility

FX futures and options can be traded on CME’s all-to-all Central Limit Order Books (CLOBs), which offer fair, no last look markets with the ability to work passive orders and hence reduce transaction costs (see recent article Is peer to peer already here?6). Pricing is firm and visible throughout all time zones and across all major currency pairs. Options are offered with a wide range of tenors and strikes - Monday, Wednesday, and Friday expiries out to one month, then monthly out to one year, then quarterly out to two years.

Alternatively, both futures and options can be traded bilaterally in “Blocks,” an OTC-style trading workflow that leverages your existing relationships with liquidity providers and potentially opens the door to many more (see recent article Block by Block7). Blocks are offered by over 20 major liquidity providers, including many of the top tier banks and multiple non-bank market making specialists. Simply trade with your chosen liquidity provider(s) as you would an OTC forward or option but gain the benefits of centrally cleared products.8

Trading via the CLOBs or via Blocks offer different execution benefits, both mechanisms ultimately generate the same post trade efficiencies and potential margin savings. And, of course, both can materially reduce the gross notional exposures that count towards your AANA thresholds when the window rolls around again next year.

In addition, many liquidity providers now offer “EFRP” trades – spreads of OTC FX versus CME FX futures, which allow transfer of risk from OTC to centrally cleared or vice versa. A growing ecosystem of users has seen volume via this workflow increase over 500 percent year-on-year. Whether swapping existing risk or a newly entered position, EFRPs allow you to obtain the benefits of centrally cleared FX in a straightforward and efficient manner.9

Be prepared for the next trend, SA-CCR

If the AANA threshold and ongoing funding costs of UMR weren’t enough, another regulatory theme that’s getting increasing attention is SA-CCR. These new rules governing how banks deal with counterparty credit risk is replacing the Current Exposure Methodology (CEM). At least one bank is said to have “widened its bid/offer spreads on short-dated G10 [FX] trades because of the new rule,”10 with others likely doing the same, especially as European banks come into scope later this year.

Since SA-CCR recognises netting benefits, previous analysis11 shows that once again CME FX futures and options can reduce banks’ capital requirements under the new rules, and hence potentially tighter bid-offer spreads could be achieved compared to OTC.

Bottom Line

  • CME’s centrally cleared FX products are exempt from the yearly AANA calculations.
  • Using CME FX products instead of OTC could bring you below the threshold for UMR rules. 
  • The AANA calculation window is now closed. If your firm has proven to have exposure above €/$8B you will be subject to Uncleared Margin Rules from September 2022. 
  • If you’ve been caught by the AANA calculation, your firm can still utilise the up to 86 percent margin savings and other efficiencies of CME FX futures and options.
  • Have confidence in the liquidity. A record number of clients are realising these benefits, and a wide array of liquidity providers support pricing.
  • Have confidence in the flexibility. Futures and options can be traded via CME’s all-to-all CLOBs or bilaterally with chosen liquidity providers as Blocks, which leverage OTC relationships and liquidity. Options cover a wide range of expiries and strikes. EFRPs allow for seamless switching between OTC and CME risk.
  • SA-CCR is next: It could lead to banks widening OTC bid-offer spreads versus centrally cleared futures and options.
  • AANA – you will be ok.

References


All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

Neither futures trading nor swaps trading are suitable for all investors, and each involves the risk of loss. Swaps trading should only be undertaken by investors who are Eligible Contract Participants (ECPs) within the meaning of Section 1a(18) of the Commodity Exchange Act. Futures and swaps each are leveraged investments and, because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for either a futures or swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles and only a portion of those funds should be devoted to any one trade because traders cannot expect to profit on every trade.

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The information within this communication has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for any errors or omissions. Additionally, all examples in this communication are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. All matters pertaining to rules and specifications herein are made subject to and superseded by official CME, CBOT, NYMEX and COMEX rules. Current rules should be consulted in all cases concerning contract specifications.

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