The birth of standardised derivatives looks set to herald a new era of electronic trading for currency derivatives and as Frances Faulds finds out, it is long overdue.
As advances in technology have meant that trading in vanilla FX options and structures is being more widely adopted, Frances Maguire looks at how pricing and execution on electronic platforms are now being enhanced.
As the FX industry enters into a new era of electronic trading for FX options, Frances Maguire examines the key role that technology is playing in the provision of new and additional services whilst redefining standards in the way these instruments are traded.
With all other instruments traded electronically and with new technology available for trading FX options, interest is now turning to the last bastion of telephone trading, writes Frances Maguire.
The FX options market is the worlds largest and most liquid options market, and while a small fraction of contracts are traded on the exchanges, most of the FX options volume is traded in the OTC market. But with the regulatory spotlight on the OTC market, and the likelihood that clearing FX options through a central counterparty (CCP) will become a mandatory requirement for banks, Frances Maguire explores where we currently stand with the electronic trading of FX options and whether a rethink is needed about how they are traded and processed in the future.
FX options today still only represent between 4-7% of the USD 4 trillion daily notional in FX, however they typically generate more than 15% of banks profits, and this disproportionate contribution looks set to grow as the switch from voice to electronic trading continues. The prospect of central clearing for interbank FX derivatives trades has seen the industry devote a significant amount of resources money, time and people to developing technical and operational capacity to cope with an arms race in electronic trading. These investments are mandatory and a strategic necessity for banks that wish to retain a competitive advantage.
Markets remain more interesting than ever. With so many evolving issues and more often than not all happening simultaneously, it is hard to keep count and to follow each developments. Yet the landscape, in which we operate and from which we make a living is changing fast. And as Darwins saying goes, those most adaptable to change will survive (and thrive).
While increasing use of electronically traded options is gradually redefining what is regarded vanilla and exotic, the move towards the development of an ECN for FX options, and the current regulatory debate around central clearing all point to one conclusion: watch this space. Where once, the more complex options structures seemed to be resigned to remain either RFQ or voice-based, this mindset is slowly being eroded as technology advances and the ease of use of options systems increases.
Increasing numbers of banks, asset managers, pension funds, hedge funds, and corporates are looking to ramp up their use of currency derivatives, both for hedging purposes as well as a component of their fund and investment management strategies. Although great strides have been made in automating much of the processing and workflow associated with Over The Counter derivatives, much still remains to be done, particularly with regard to cost savings and risk management.
The recent disasters in the global banking system and the ensuing fallout in the derivatives markets fundamentally changed the way market participants use FX derivatives. The crippling widespread disappearance of liquidity and leverage as well as the over-regulation that many doom sayers predicted has not materialised; instead, market participants are refocusing on the core uses of derivatives that built the industry. Concurrently, there are greatly increased efforts at addressing systematic problems with efficiency and operational risk. In addition, regulators are preparing sweeping reforms to the OTC derivatives markets on both sides of the Atlantic and FX derivatives are in danger of being caught up in these reforms.
The recent volatility has put FX options trading firmly in the limelight. The technology to price and trade these instruments electronically is available, but whether the appetite is there for the automation of the more exotic structures remains to be seem. Frances Maguire investigates.
There is no question that the financial industry is in a dramatic state of change. If we can be sure of one thing right now, it is that there will most certainly be a raft of regulations and reforms introduced which will require all of us to implement new processes and revisit the way we carry out our business. A large proportion of these changes will be centred on the electronic communication of trades.
"Very user friendly but very sophisticated," is how Udi Sela, currently Pre Sales Director at SuperDerivatives describes its options pricing product, SD-FX. We tend to agree. With the release of its FX Next Generation version SuperDerivatives has once again shown its exceptional ability to respond to customer demand for new product features.
The growth of electronically traded FX options by retail traders, both over the counter and on-exchange, is already taking off as more sophisticated retail investors look for new trading and hedging opportunities. In response, brokers and banks are rapidly developing e-FX trading platforms that support and educate investors about the different products and trading styles available, and FX options is being pitched as the fastest growing new revenue stream in FX.
Frances Maguire asks if the FX industry will ever successfully trade FX options electronically or if the hybrid model is here to stay.
Dr David Gershon outlines the evolutionary pathway leading towards online option trading
Jennifer White outlines why, with the broad range of derivative products on offer, it is important to use all available technological tools to support this complex business.
Michel Everaert explains how APIs free banks to concentrate on providing a tailored service to their clients.
Andy Webb interviews a selection of leading banks about the functionality of their own online FX Option trading platforms.
Transparency versus Liquidity - is there a winner? David Gershon discusses how greater transparency now means everyone can determine an options fair price in advance of trading.