Adjusting positions to a further maturity (settlement) date, otherwise known as “rolling,” “rolling forward,” or “rollovers,” is a common feature in OTC and exchange-traded FX markets. Examples of OTC rolls are funds moving exposures from month-end to month-end, or the “Tom/Next” (tomorrow next) roll to extend a spot position from settling today to settling tomorrow.
All things being equal, clients across the buyside have been able to source very competitive pricing to complete their rollover trades across the maturity spectrum but several factors are combining to potentially cause clients to reconsider how and where they source pricing and liquidity to optimize their activity.
In a recent article by FX Markets, they cited commentary that the spreads for rolling risk from December to January were at the widest levels seen for over six years and that three month forward prices have increased more than seven and 10 times since the start of the year for GBP/USD and USD/JPY, respectively.
Market volatility driven by geo-political risks and uncertainty around central bank interest rate policy are clearly fundamentally important to pricing in the FX markets, but in addition are the result of regulation (e.g., SA-CCR and UMR), and bank balance sheet management, which comes to the fore around the ‘year-end turn.’
A clear(ed) view on pricing and liquidity
The cleared, listed FX market sees very similar rollover activity to the OTC market, although with all the activity focused on standardized dates that are either monthly or quarterly IMM dates. With buyside participants (i.e., Asset Managers and Hedge Funds) holding over 60% of open interest in major pairs, the listed market then provides an interesting point of reference, and potentially complementary liquidity to traders who otherwise would use purely pricing from their liquidity providers in the OTC market.
The data below references activity in the September quarterly roll, which looks at roll activity for traders who were holding a September maturing contract and who then either closed out (exited) that risk, took the position to physical settlement, or who “rolled” their position forward (typically to the December IMM date). For the Sep-22 contract month, across the G5 currency pairs $25 billion of FX futures positions were taken to delivery (physical settlement of the underlying currency pairs).
|Currency||Average Daily Traded Volume September (USD)||Open Interest as of Sept 2ND (USD)||% of Open Interest Rolled From September to December|
Source: CME Group
The most commonly used mechanism to achieve a rollover in the futures market is to trade a “calendar spread” where you simultaneously sell the front month and buy the back month (or vice versa). Per the table below, spreads have a lower minimum price increment, and the CME Group order book was at this minimum price increment for over 90% of regular trading hours during the September roll (e.g., an average top of book spread of 0.21 pips for EUR/USD).
In addition to the firm, no last look liquidity in the central limit order book clients can also approach one of over 20 liquidity providers for a relationship-based price that is negotiated on an OTC basis and leaning on OTC liquidity. For these block trades, the minimum price increment is finer, potentially allowing clients to further optimize their roll activity.
|Currency||MPI OUTRIGHTS (CLOB)||MPI QUARTERLY CALENDAR SPREADS (CLOB)||MPI BLOCKS (SPREADS AND OUTRIGHTS)|
Source: CME Group
In the OTC market customers typically poll their counterparts via RFQ to understand where the market is and to compete their liquidity providers against each other for pricing on the desired transaction. As such the customer is seen as the “taker” with the liquidity provider acting as the “maker.”
Within a central limit order book that is truly all-to-all this dynamic shifts to allow every participant to provide liquidity to the marketplace if they so wish, potentially allowing buyside clients to trade passively and earn or at least avoid paying away a full spread on their activity. Looking at EUR/USD outrights during Q3 2022 we saw Asset Managers trade passively 51% of the time and Hedge Funds trade passively 74% of the time. Then for calendar spreads during the September roll period, these levels became 35% for Hedge Funds and 37% for Asset Managers.
When is best to roll?
Calendar spread trading in futures occurs every day, but activity is more significant during the roll period, which is generally considered to be the two or three weeks prior to the quarterly IMM date.
For EUR/USD futures, open interest in the Sep-22 contract peaked on August 22. For the G5 FX futures combined, open interest peaked on September 1. Looking at the open interest positions in the three weeks prior to the Sep-22 contract’s last trade date, the bulk of movement occurred in the week prior to expiry, when 73% of peak open interest moved to the Dec-22 contract. In comparison, 9% of open interest moved in the second week prior to expiry, and there was limited net movement in the week before that.
Within the last full week of trading prior to expiry, the most active day for the roll across the G5 currencies was Wednesday, with Thursday being slightly more active for CAD/USD. On Wednesday September 14, U.S. $69 billion in notional value was moved from September to December.
These roll volumes are in addition to the $36 billion per day on average that was traded in the outright September and December futures markets during this period.
Looking more closely within the trading day, the data shows that roll activity is heavily focussed in the prime European and North American trading hours, with the cross-over period between the two time zones being the most active period.
Across the combined G5 FX futures, the most active hour in the last full week before the expiry came between 2:00 a.m. and 3:00 a.m. Central Time, when $8.8 billion was moved between Sep-22 and Dec-22 contract months using CME Globex calendar spreads.
OTC (block) vs. CLOB: Can large roll trades be executed in the CLOB?
While a couple of very large spread block trades were recorded during the period, overall block trades represented only 3.1% of the overall spread volume. This is in part because the depth of liquidity in the CME Globex orderbook allowed for many larger trades to be executed electronically.
Many trades, which would be large enough to be executed as block trades, were transacted through the orderbook. In fact, 78% of the volume traded as a spread on CME Globex was large enough to be traded as a block. Moreover, 44% of spread volume was in a trade, which was 10 times the block trade threshold (with the block threshold for EUR/USD being EUR 18.75 million).
Looking at hourly average quoted size shows how the liquidity available on the CME Globex orderbook developed. During the core hours of the roll in the week of September 12, the average quoted bid-offer size across the G5 currency pairs was between $1.5 and $2.0 billion.
Liquidity can also be demonstrated by looking at the quoted bid-offer spread. Even with the 50-60% reductions in the minimum price increment for G5 calendar spreads that was made several years ago, CME Globex spread markets were frequently quoted at the minimum increment allowing for enhanced price discovery and reduced cost of trading for end user participants.
In total, $210 billion was transferred in CME Group futures Sep-Dec spread trades among the G5 currency pairs in the three weeks prior to the September futures expiry, which helps to reinforce that the listed FX market provides a large pool of liquidity to assist with price discovery and complementary liquidity for customers to consider. With the year-end turn looming and the impacts of SA-CCR continuing to be understood, access to additional liquidity that results in a cleared, netted future that can assist with optimising the impacts of both SA-CCR and UMR may become increasingly relevant.
CME Group has a Pace of the Roll tool, which provides an analysis of the progress of the quarterly roll as it takes place.
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.