Across the FX swaps market, demand for automation and electronification is rapidly gaining traction, however, for panellists speaking at TradeTech FX on Wednesday, this will likely translate into a gradual shift, rather than an immediate boom.
Simon Jones
Across this sector of the industry, growth in electronification is certainly notable, and as Matt O’Hara, chief executive of 360T, highlighted: “If you look at the growth of bank-to-bank business in swaps, that up to 95% over the last three years. I would argue that electronification is occurring, but it’s occurring away from what we expected, which was activity within the primary venue.”
Specifically, the FX swaps market currently constitutes 60-80% dealer-to-dealer activity (D2D), whereas the spot market is half the size of its swaps counterpart, but is approximately 90% electronic.
Explaining the gaps in electronification in the FX swaps market, panellists pointed towards the early days of the market, which started with voice brokers instead of electronic platforms.
Despite this, there is a particular push from banks for automation to reduce credit and regulatory cost burdens.
Explaining this demand, O’Hara further added: “The market is in the process of transformation right now and we’ve got banks at the table that want to be able to automate and digitise these businesses to reduce costs in this marketplace.”
However, although electronification is on the uptick across the FX swaps market, obstacles still remain, and voice trading and D2D are still relevant, largely due to the market’s complexity and credit considerations.
Speaking to this, Simon Jones, group head product and liquidity at LSEG, asserted: “The question is if we’d invested 10 years ago, would the market be different? Is it us, or did the market need to move for us to invest? I think that’s up in the air.”
Read more – Why resilience is now the measure of successful FX automation
Moreover, panellists further highlighted that trust and confidence are essential requirements from banks before they are able to fully proceed with automation and digitising swaps, indicating that the swap market will experience slow adoption – also due to the necessity to integrate many counterparties and credit engines.
Alternatively, although the consensus from the buy-side panellists at TradeTech FX is positive, with these firms typically reporting good pricing and liquidity, indicating that credit costs are mostly borne by banks.
Echoing this sentiment, Nick Van Nifterick, senior portfolio manager at PGB pensioendiensten, added: “We have a fully integrated system with an EMS/OMS, and 90% of what I trade is indeed the FX swap against the Euro. I do not discover that I have a lack of liquidity.”
Clearing as a market structure hurdle
When discussing where the key challenges lie to fully opening and digitising the FX swaps market, panellists also pointed towards credit risk and clearing requirements.
Specifically, clearing solutions are developing across this market, however do not serve as a complete fix for credit and balance sheet constraints – or, as Jones describes, will not be the ‘silver bullet’, due to temporary credit shortfalls and potential crisis scenarios.
“There is potential for credit shortfalls and balance sheet issues on a temporary basis, or we may have another financial crisis,” Jones continued.
“If things begin to look iffy like they did around 20 years ago, quickly attempting to get into the clearing game won’t be an option. At that point it’ll be too late.”
Building on this, the panel further emphasised that clearing solutions for FX swaps will likely be a part of many banks’ toolkits within the next year or so, but this development does not mean that all credit frictions will be eliminated.
Similarly, banks and platforms appear to recognise that full clearing is not feasible for all swaps, especially funding and directional hedging products.
Overall, as banks continue to seek greater efficiency, the evolution of FX swaps will ultimately depend on how effectively the industry can tackle the credit, clearing and integration hurdles that continue to shape the market.