CME FX Link creates a seamless connection between the FX futures contract and the OTC FX marketplace as a CME Globex-traded basis spread. The spread results in a simultaneous execution of FX futures cleared by CME, and OTC spot FX, subject to OTC documentation and credit relationships.
In this lesson, we will discuss CME FX Link terminology, product information and the execution workflow when trading FX Link.
CME FX Link will be quoted in terms of the differential between CME FX futures and the equivalent OTC spot FX - sometimes referred to as the basis or forward points.
The usual quotation method is futures minus spot. Spread levels can be either positive or negative, depending on market conditions and the currency pair.
Factors that affect the pricing of the futures include the FX spot level, the interest rate differential between the two currencies and the amount of time between spot trade settlement and the final settlement of the futures contract.
As a futures contract approaches its expiration, the time value of the interest rate differential runs out and spot and futures converge.
CME Group has initially launched CME FX Link with six currency pairs: EUR/USD, GBP/USD, AUD/USD, USD/CAD, USD/JPY, and USD/MXN.
CME Group FX futures are not always quoted in their spot market conventions. For example, of the six currency pairs to be initially listed in FX Link, three are quoted in inverse terms as futures contracts. Those three are Canadian dollar, Japanese yen and Mexican peso.
This inverse quoting convention means that if a trader holds like positions in the underlying currencies, a trader holds opposite positions in the currency pairs. For example, a trader who wishes to take a long position in USD and short position in MXN would buy USD/MXN in the OTC spot or forwards market or short MXN/USD in the CME futures market.
In the context of CME FX Link, a trader seeks offsetting positions in the spot and futures market to buy or sell basis. By way of example, a trader seeking to buy basis between Mexican Pesos and U.S. Dollars would sell the MXN/USD future (i.e. short MXN, long USD) and sell the offsetting amount of USD/MXN spot (i.e. short USD, long MXN).
The three currencies: EUR/USD, GBP/USD and AUD/USD, trade FX Link in the same convention as their spot market, or non-inverted, terms.
For FX currencies traded in non-inverted convention, the buyer of the spread buys CME FX futures and sells OTC spot FX. For inverted currencies, the buyer of FX Link sells CME futures and sells OTC spot FX.
This will be an important consideration when viewing the FX Link quotations and the final resulting FX spot and futures positions created by an FX Link trade
The minimum price fluctuation for FX Link will be different for each currency. Market participants should consult contract specifications for details.
Each FX Link trade results in two positions: one is a futures contract cleared at CME Clearing via normal FCM channels. The other is a spot FX position facing the trader’s prime FX broker (or directly facing the Central FXPB).
For the FX futures leg, when an FX Link trade is executed, the last trade price in the corresponding FX futures product is assigned as the futures leg price and is used in conjunction with the traded spread to determine the spot FX price.
For example, the EUR/USD basis trades a 5 lot at .00001. Participant A buys basis, which is equivalent to buying futures and selling spot. While Participant B sells basis, which is selling futures and buying spot.
The futures price is 1.20355. The spot price is 1.20354, which is the futures price minus the traded basis spread.
Post execution, the futures leg of the transaction for the market participant’s trade flows through to their futures commission merchant, or FCM, just like a regular futures transaction.
Through CME Clearing, the futures leg will be cleared, a position established and the open position will be subject to margin, just like any other futures position. This ensures anonymity and mitigates counterparty trade risk.
The trader’s position will reflect the FX futures transaction; there are not separate futures contracts for FX Link.
The FX spot leg of the spread is centrally intermediated by a Central FX Prime Broker (FXPB) with traders of FX Link either facing the Central FXPB directly, or facing their own FX Prime Broker who in turn faces the central FXPB.
This model enables anonymous trading via the FX Link spread and the resulting FX spot position is then between those counterparties as CME is not involved in settlement or intermediation of the spot transactions.
FX Link creates a seamless connection between FX futures and the OTC FX marketplace – allowing market participants to use one CME Globex spread to more easily access the efficiencies of FX futures and better manage their FX exposures.