Compression Grows in FX
Interdealer broker Tradition has partnered with LMRKTS to launch compression in foreign exchange forwards before expanding the service into other asset classes.
Dan Marcus, global head of strategy and business development at Tradition, told Markets Media: “We are starting with compression in forward FX but over the coming months and years we intend to expand to several other asset classes.”
Compression is a process in which clients can “tear-up” offseting trades in their portfolios to reduce the notional outstanding and number of line items in their portfolio while maintaining the same risk exposure. Use of compression services has increased following the introduction of stricter capital requirements, such as the Basel III leverage ratio, which has led to banks reducing their balance sheets and capital efficiency becoming increasingly important.
Marcus said Tradition’s strategic focus is to provide clients with flexible execution capabilities through enabling the easiest and most flexible way to find a trading counterparty either electronically, by voice and/ or via a hybrid model.
“However, in areas down the value chain we work with independent infrastructure and/ or providers who can specialise in their specific areas of expertise,” added Marcus. “This should produce a symbiosis of product delivery that provides the best value proposition for our mutual clients. In this instance we are delighted to be working with the compression/ optimisation experts LMRKTS.”
LMRKTS was founded in 2011 by Lucio Biase, a former credit risk analyst at Lehman Brothers, who has also held structuring and trading roles at Credit Suisse and hedge fund Marathon Asset Management. The firm said in a statement that it has been discreetly working on this foreign exchange solution with a select number of banks for over a year.
On its website LMRKTS said that before signing up to a compression round, participants’ risk teams gather the necessary position or exposure data, set bespoke limits and define objective functions. This data is then submitted in the clients’ preferred format via a secure, online portal.
“The multi lateral nature of each compression round results in unprecedented savings, and trades are executed below typical trading costs,” added LMRKTS.
Tradition has built a platform to execute the results of a compression cycle, but does not have data on the original portfolio positions which are being compressed. A limited release of the compression service is planned for August and a full commercial release later this year.
Compression has been widely used in other asset classes, such as interest rate swaps.
“When you are starting a new service you want to find the best angle to provide something innovative, which is not necessarily being covered by incumbents,” added Marcus. “The capital saving potential for FX forwards can be significant – and perhaps greater than interest rate swaps – at around 90%.”
In May LCH, the clearing house owned by the London Stock Exchange, said its SwapClear service had compressed $1 quadrillion in notional, or more than 8.4 million cleared interest rate swap trades, since it started offering compression services in 2008.
Cameron Goh, head of clearing solutions, SwapClear and listed rates at LCH, said in a statement at the time: “Capital efficiency is top of mind for many banks, who are looking for ways to drive down their notional outstanding. As a result, demand for compression services are at an all time high.”
At the beginning of this year the International Swaps and Derivatives Association, said clearing and portfolio compression are having an increasingly significant effect on the interest rate derivatives market, with more than two-thirds of notional outstanding now cleared and compression reducing the size of the market by approximately 62%.
Isda said in a statement: “An estimated 67.1% of total interest rate derivative notional outstanding was cleared at end-June 2015, reflecting a rise in the use of clearing houses in recent years – in response to clearing mandates for certain products in some jurisdictions, but also due to risk, capital and operational efficiency reasons. This compares to 21% at year-end 2008.”
More on compression:
Algorithms have become more prevalent in the spot FX market.
Global Foreign Exchange Committee has made recommendations on Last Look.
There is a growing demand for transparency in FX trading by regulators.
CLS has also enhanced its existing suite of alternative FX data products.
FX Global Code sets out good practice for last look and provides illustrative examples.