This article discusses how buy-side customers are using our futures markets to manage risk, what’s driving their decision-making, and how we have seen their appetite for our markets expressed in both holding large open interest positions and being translated into volume.
The insights contained here are based on our discussions with over 90 buy-side accounts in the last six months.
As of September 8, the CFTC reported that the number of traders with large open positions in CME FX futures was once again over 1,100. Following the all-time record of 1,310 on Feb. 25, this number had fallen to around 940 with traders across both hedge funds and asset managers flattening their books or downsizing their positions as a result of the volatility in March.
The supposedly quiet summer months did, however, see continued activity in the FX markets – with positioning in EUR against USD as one of the most obvious trends over the course of much of Q3. This trading activity resulted in +8.6% growth in the number of large open interest holders in CME FX futures over the last 13 weeks.
Volumes in FX futures have also illustrated growth in activity across both G10 and Emerging Market currency pairs, with total average daily volume (ADV) in July up 11.2% versus July 2019. Standout growth in the CME complex includes currency pairs such as EUR/USD (+29%), NZD (+24.6%), BRL (+35.8%), and RUB (+106.3%).
|Pair||$ Notional for 31 July 2020||2020 YTD $ADV||July 2020 v July 2019|
|Total FX Futures||F||$108,650,640,183||$76,684,762,770||11.20%|
|New Zealand Dollar||F||$2,569,863,340||$1,946,134,388||24.60%|
|South African Rand||F||$156,640,925||$114,590,032||5.10%|
Source: CME Group
These volumes have led to significant records in terms of client positioning that is also captured in reporting from the CFTC; for example, asset managers reached their all-time largest net long position in CHF (4 August), EUR (18 August), and JPY (25 August) against the US Dollar.
Overall open interest has also grown in line with the increased volumes and new client adoption, with EUR/USD leading the trend, breaking through its open interest record 10 times during 2020 and reaching more than $121bn as of September 14th. Drilling further in to the data we were able to see buy-side clients playing a significant role within this overall growth trajectory, with Asset Managers holding 39.4% and leveraged funds holding 9.5% of open interest in EUR/USD futures as of Sept 15th.
Source: CME Group, data as of Sept. 14 2020
The reference points of volume and open interest don’t, however, provide any color as to why clients are choosing to manage and express their FX exposures via listed FX futures either instead of or in addition to bilateral OTC FX trades. As such, we approached more than 90 buy-side accounts during Q2 and Q3 2020 to better understand their drivers for using FX futures as well as reasons why some of their trading remains in the OTC marketplace.
The cost comparison between listed FX and OTC FX is a topic that frequently comes up with customers but remains one that is hard to evince in an ‘apples for apples’ manner. Fees for CME listed FX futures are an ‘all in’ cost that include both execution and clearing costs, and with the resulting position facing a highly regulated CCP as opposed to a bilateral or prime brokered trade. As such, there is no bilateral equivalent to directly compare the CME fees against. Moreover, different customers are focused on different cost elements – with some focusing on purely quantitative aspects and others also including qualitative differences when comparing their choices of where and how to trade.
From an execution cost perspective, the Minimum Price Increment (MPI) reductions of 50-60% in quarterly roll spreads of G5 FX futures have enabled customers to trade listed FX more cost effectively, which has acted as a tailwind behind the increased activity in the quarterly roll – e.g., 85% of EUR/USD open interest was rolled in June which was +8% above the historic average.
Some clients, however, focused purely on the exchange fee for trading and clearing FX futures, and looked at this on a standalone basis as an additional cost to their business. Whilst there undoubtedly is a charge from CME for the trading of listed FX futures, we encouraged these clients to utilise a more ‘total cost’ approach – and so also consider factors such as platform fees for OTC trades, prime broker fees (if applicable), the mitigation of counterparty risk, and also the potential savings achieved via trading passively and having no last look in the CME CLOB.
A broader consideration on costs also includes legal agreements and ISDAs. Some clients we spoke with have funds that don’t have an ISDA or struggle with the ongoing costs of maintaining ISDA agreements as well as the operational processes of facing multiple banks on a bilateral basis. FX futures enable customers to access the FX markets without the need of an ISDA or bilateral credit lines, whilst also enabling all the positions to be netted and settled via one FCM relationship.
The volatility of March resulted in some very mixed experiences from customers as to how their access to market and liquidity fared in the OTC markets. Some customers just noted a natural widening of spreads, whilst others noted some banks pulling lines or refusing to quote altogether. Nonetheless, many customers absolutely value and continue to need the relationships they have with their panel banks and as such can’t envisage a world that is purely anonymous and electronic.
This topic enabled further conversations on the role of blocks and EFRPs within the listed FX marketplace. These trading modalities enable clients to negotiate and trade on an OTC basis directly with their chosen counterparts, but to then end up in a centrally cleared FX futures. As such, blocks and EFRPs are very appealing to customers wishing to maintain and utilise their bank relationships but to then hold a netted, cleared, and capital-efficient FX position.
The trading and market activity of 2020 has renewed the focus for many customers we spoke with on the need to have access to multiple sources of liquidity and multiple venues to help understand where the market is trading, and to have transparency in to their execution costs to help ensure that their fiduciary duties are fulfilled.
In this context, the construct of a regulated central limit order book with credit agnostic pricing on an all-to-all basis resonated with many of the traders. In particular, the volatility of late Q1 2020 and associated stresses in the FX marketplace highlighted the potential impact of ‘last look’ pricing to customers, which, whilst hard to fully quantify, helped to reinforce the value of access to firm liquidity via FX futures.
In addition to trading on firm pricing, the ability to work orders in the CLOB and to trade passively resonated with a range of customers including both large Hedge Funds and Asset Managers. Trading passively enables clients to be taken out of positions whilst earning / not having to pay the bid-offer spread in the process. In a study conducted by Greenwich Associates,1 participants reported executing FX futures at mid, 35% of the time on average, and so even the narrowest of spreads available in an aggregator may be avoided to further improve execution and reduce costs.
Even with the differences and benefits of futures mentioned above, many of the traders we spoke with utilize both OTC FX as well as futures, viewing the two markets as complementary sources of liquidity. For these traders they find it positive that FX futures and OTC FX can be viewed and executed via common industry platforms such as Bloomberg, and this also provides an easy way for clients who are not currently familiar with using FX futures to at least keep an eye on what is happening in our CLOB. We feel that the diversity and size of our ecosystem can help provide another valuable data point as to where the market is trading and another mechanism to access the market if OTC is less efficient on a given trade or for a given strategy.
Phil Hermon serves as an Executive Director of FX Products at CME Group and is based out of London. He is responsible for the management, development and go to market initiatives of Listed FX and OTC cleared FX products. Before joining CME Group, Phil served in various roles across sales, client solutions, derivatives operations and relationship management at both Morgan Stanley and RBS.
Prior to his career in finance, Phil was a Captain in the Royal Tank Regiment within the British Army and holds a bachelor's degree in business studies from the University of Sheffield.
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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