Many had been expecting the move to make enforce the mandatory clearing of non-deliverable forwards (NDFs) to be a fait accompli for 2015. Far from it. The announcement from the European Securities and Markets Authority (ESMA) also puts into doubt the Commodity Futures Trading Commission’s (CFTC) likelihood of implementing central clearing in the US, at a time when FX markets have seen huge volatility and volumes. Indeed, according to figures from settlement company CLS, global daily turnover hit over $9 trillion in January, a massive jump from the last Bank for International Settlements’ survey which had average daily volumes at $5.3 trillion in 2013.
Turbulent markets, combined with a massive expansion in traded volumes, the FX fixing scandal and a scaling back of dealer activity, have created new challenges for the FX business these past few years. Regulators had been giving strong indications that they were imposing new rules to increase transparency in the market— including central clearing and a push towards exchange trading.
With ESMA’s announcement the first seems unlikely in the near-term.
“There is a pause in the regulatory push for NDF clearing in Europe,” said Craig LeVeille, executive director, FX products, at CME Group. “This is seems reflective of the US too. We have been waiting for the CFTC decision since last year—but the decision by ESMA seems to anticipate a CFTC pause. I think the regulators have other issues on the agenda short-term.”
So why did ESMA change its mind? In part, it is a question of preparation. In Europe there is only one clearing house—LCH.Clearnet— currently authorised to clear NDFs. NDFs are also more difficult to centrally clear than spot because of the varying legal definitions in different jurisdictions around the world. Beyond this, however, there is a more general feeling that participants don’t want to go through the administrative burden or the cost to change the current structure.
“The primary reason for clearing interest rate swaps doesn’t apply to FX,” says Bryan Hunter, head of foreign exchange at Interactive Data. “The general industry sentiment is that FX pricing and access to the market is open and transparent enough. We have heard that NDF clearing will negatively impact liquidity.”
At present LCH.Clearnet will typically clear notional amounts of between $3 billion to $7 billion from 300 to 500 trades per day— a very small proportion of the overall market. However, the proponents for central clearing should have built up a strong case in the last six months. The volatility seen in FX markets in that time has been almost unprecedented. First came the Russian rouble crisis which drove daily volumes above the $10 trillion mark in December last year. And then, this year, was the FX equivalent of the equity flash crash when the Swiss National Bank’s (SNB) removed the Swiss Franc cap against the Euro creating carnage in the market and leading to a handful of currency firms going bust, thus putting the spotlight once more on the issue of counterparty risk.
While regulators could confound expectations and get a new central clearing standard passed this year, given that it has taken this much time to get nowhere fast, one shouldn’t hold one’s breath.