FX Forwards Move Toward Clearing Mandate

Terry Flanagan

OTC markets are preparing for mandatory clearing of FX non-deliverable forwards, which represent a small but growing segment of the overall FX market.

“The area we’re watching closely is the FX space,” said George Harrington, global head of fixed income, FX and commodity trading at Bloomberg. “We’re expecting the regulators to propose a date for mandatory clearing, probably sometime early next year. We expect that some of the SEFs will make a MAT (Made Available for Trade) determination on the FX NDF swap.”

The U.S. Commodity Futures Trading Commission convened its Global Markets Advisory Committee on October 9, where it announced the members of a new Foreign Exchange Markets Subcommittee to provide advice whether mandatory clearing should be required of NDFs. The European Securities and Markets Committee has issued a consultation on NDFs as well.

OTC foreign exchange contracts represented $70.6 trillion in outstanding notional amounts and $2.3 trillion in market value, accounting for 9.9% and 12.2% of the OTC derivative market respectively as of December 2013, according to the Bank of International Settlements.

OTC foreign exchange derivatives are therefore the second largest asset class both in terms of notional amounts and market value, although NDFs only represent a fraction of the global OTC FX derivative market.

In some countries, monetary authorities impose restrictions on the convertibility of their currency to regulate the inflow and outflow of currencies. Therefore, it may be difficult for counterparties located outside those countries to enter into physically-settled FX forward contracts because such transactions might not be allowed under the currency restrictions.

As a result, the demand has grown for NDFs, which do not require any payment in the non-convertible currency. In contrast to FX transactions, which are based on full principal exchange, NDFs do not require payment or receipt of underlying principal amounts and as such are fundamentally derivative contracts with a high degree of inherent leverage.

LCH.Clearnet created its ForexClear service to alleviate counterparty credit risk in the FX market, Gavin Wells, global head of ForexClear and CDS, said at the Oct. 9 CFTC meeting.

“The market wanted counterparty credit risk mitigation,” said Wells. “That’s been delivered for the asset class we can currently clear, which is cash-settled NDFs.”

With capital margin required looming in December 2015, he added “we are working with the market to manage intraday liquidity risk, and thus delver a clearing service for the other FX product, FX, options, in time for that deadline in some 14 months’ time.”

Featured image via adimas/Dollar Photo Club

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