FX play bodes well for CME’s European derivatives gambit

The planned launch of a derivatives exchange in Europe next year by US market operator CME Group could be more successful than other new entrants, observers say, due to its initial focus on FX.

The planned launch of a derivatives exchange in Europe next year by US market operator CME Group could be more successful than other new entrants, observers say, due to its initial focus on FX.

Subject to regulatory approval by the UK’s Financial Services Authority, CME Europe will being trading in the middle of next year, initially offering trading in foreign exchange futures.

The new exchange will be managed by Robert Ray, who is currently managing director, products and services at CME, and will be underpinned by the CME’s Globex technology platform.

While other planned and recently launched derivatives markets have concentrated on breaking the stranglehold of Deutsche Börse-owned Eurex and NYSE Euronext’s Liffe exchanges in European interest rate products and stock index futures, CME Europe will tackle a market that is still largely traded among banks themselves.

Ray told theTRADEnews.com, “It will be interesting to see how many markets are left standing at the end of next year. Market participants will be looking at the value proposition and economics of each market before spending on the costs associated with connecting to each new venue.”

Ray added that the CME’s US market already derives 30% of its FX volume from European market participants and that the new venue will align its pricing so that it is similar to swap market conventions. CME trades around US$120 billion per day in the 56 currency pairs it offers on its US market, which include futures and options on G10 currencies and emerging market currencies, and e-micro FX futures.

According to a research note from Brad Hintz, senior analyst at AllianceBernstein, linking a trading venue to CME Clearing Europe will offer new opportunities for the market operator’s new venture.

“With all the OTC product capabilities available in the European clearing house, a linked futures exchanges may be able to rollout futures products that allow hedging and futures trading against the OTC books that will begin to settle at the new venue,” read the note.

According to Ray, CME has spent three-and-a-half years building the support and infrastructure for the new European venue.

MTF challenge 

Other exchange operators looking to grab a slice of the derivatives market in light of impending reforms – which will standardise OTC derivatives where possible so they are suitable for exchange trading and central clearing – include London Stock Exchange-owned multilateral trading facility (MTF) Turquoise and Nasdaq OMX.

Turquoise plans to use its parent company’s recent acquisition of index provider FTSE to add new instruments to Turquoise Derivatives, while Nasdaq OMX will launch NLX, a MTF for short- and long-term euro- and sterling-denominated interest rate swaps, in Q1 2013. Meanwhile, interdealer broker ICAP is widely tipped to use its recent acquisition of UK exchange PLUS Markets to establish a derivatives venue and BATS Chi-X Europe has also been plotting its own derivatives markets foray based on a proprietary set of stock indices known as the CHERI series, developed in conjunction with Russell Investments.

But according to Richard Perrott, diversified financials analyst at private German bank Berenberg, the success of many of these initiatives depends on regulation working in their favour.

Richard Perrott, Berenberg Bank“CME Europe is positioning itself ahead of OTC reform and the incentive to use more standardised, clearable instruments.” said Perrott. “Assuming Turquoise and Nasdaq OMX look to challenge the European incumbents head-on in interest rate derivatives, it's harder to see them being successful without significant regulatory change via MiFIR. It is simply not enough to compete in the derivatives market with low prices as new entrants have done for cash equities.”

MiFIR, which is slated for introduction in 2014 at the earliest, is the regulation accompanying MiFID II, and currently aims to ensure that trading venues are able to access the central counterparties of their choice.

Banking on reforms 

But non-discriminatory clearing access is far from certain, according to Perrott, as there is already significant opportunity for competition in the derivatives market. For example, he noted that there are numerous equity index providers that trading venues can base derivatives contracts on. Perrott also pointed out that Deutsche Börse and NYSE Euronext did not offer open access to their respective clearing houses as part of efforts to gain approval for their merger by European competition authorities. Despite making a number of other concessions to the European Commission's competition authority, the Deutsche Börse/NYSE Euronext merger was rejected in February because of the potential monopoly it could create in listed derivatives trading.

If trading venues can clear trades with the CCP of their choice, market participants are more like to use them because of the ability to use cross-margining capabilities.

Market participants have pointed out that if CME Europe finds success in FX derivatives, it could provide an extra impetus for regulators to follow through with open access to CCPs so that CME can compete in other areas.

While fragmentation in derivatives may take a different course to equities, the need for sophisticated technology following the introduction of new rules could be more similar.

“There will be a new type of workflow for derivatives as more venues emerge,” said Steve Grob, director of group strategy, Fidessa. “We are seeing more demand for this in terms of use of algos, analytics and smart order routing.”

Fidessa recently signed deals with Citi and Newedge to help the brokers prepare for the introduction of new swaps rules.