No Clear Path For FX Market Users in Europe

Terry Flanagan

With the start date for mandatory clearing of standardized over-the-counter derivatives looming, and many of the rules still seemingly to be finalized, foreign exchange market participants—especially in Europe—are still unsure as to how the FX landscape will shape up.

As Europe begins to catch up with the progress made in the U.S. with the Dodd-Frank Act over similar measures that are being introduced in accordance with the G20 group of nations’ diktat to introduce far-reaching reforms to the previously opaque $700 trillion global OTC derivatives market to prevent another global financial crisis, the European Market Infrastructure Regulation (Emir) is just awaiting its technical standards to be written before the European Commission can rubber stamp the new rules.

The new rules aim to drive all standardized OTC derivatives trades on to electronic exchanges before being central cleared with the view to reducing counterparty risk, as well as the reporting of all derivative contracts to trade repositories, which will offer market participants a clearer view of the derivatives markets.

But FX participants have always argued that moving some FX trades through centralized clearing would actually jeopardize the trades, such as in the forex swaps and forwards market. These wishes appear to have been granted, but there are still some grey areas.

The European Securities and Markets Authority (Esma), the pan-European regulator, has until September 30 to finalize the draft technical standards on Emir but many FX market users are worried that the new European forex rules will diverge from those already written down in Dodd-Frank.

In the U.S., the new rules, which are likely to come into force from mid-October, say that FX swaps and forwards will be exempt from the new regulations but clearing and reporting of non-deliverable forwards (NDFs) and eventually forex options will be subject to the new rules. There are, however, concerns in Europe that Esma may exempt NDFs from the clearing process, which would prove unpopular with banks and clearing houses who have already spent considerable resources in anticipation that NDFs would be centrally cleared. Other market users are also unsure as to how more complex instruments, such as FX options, are actually going to be centrally cleared with Esma giving little away. The new rules in Europe are expected to go live from the start of 2013.

“There is a continuing and undesirable lack of clarity over the position of FX transactions, which it would be helpful if Esma could dispel,” said the Investment Management Association, a trade body, in its comment letter sent to Esma last month regarding the technical standards on Emir. “We do not believe FX contracts are exactly comparable to other OTC derivatives contracts.”

However, some post-trade providers are looking to gain an early-mover advantage by rolling out solutions for OTC FX clearing to provide forex users with least impact to their current business models.

Traiana, which is owned by U.K. inter-dealer broker ICAP, has announced that the two largest foreign exchange trading platforms—the ICAP-owned EBS and its main rival Thomson Reuters—have selected the Traiana Harmony network for connectivity to OTC client clearing firms and central counterparties (CCPs).

Clients will then have a ready connection to submit their trades to clearing houses and clearing brokers without additional cost or infrastructure investments, automating the clearing of OTC FX derivatives and delivering compliance with OTC clearing regulations.

“The introduction of FX clearing requires new processes and technology for market participants, and it continues to evolve as rules are finalized in the U.S., Europe and Asia,” said Gil Mandelzis, chief executive of EBS.

Traiana says its Harmony CCP Connect will also provide a comprehensive solution for OTC FX clearing, including connectivity, workflow automation, trade matching and affirmation. With a single connection to Harmony, Traiana says it will provide access to all CCPs, thus lowering costs and complexity for market participants. Harmony CCP Connect can also provide a gateway to the leading FX trading and post-trade venues, ensuring buy-side firms can use their preferred trading, allocation and confirmation venues with complete interoperability.

For firms trading on Thomson Reuters or EBS, this will allow them to trade, allocate and confirm using their existing processes, but adds integration to the clearing processes of the CCPs and client clearing firms. The solution also supports all proposed U.S. and European clearing rules and workflows as they stand.

“We’ve worked very closely with the leading FX trading venues for years to automate post-trade and manage risk in FX trading,” said Andrew Coyne, chief executive of Traiana. “By joining forces with EBS and Thomson Reuters, we provide an end-to-end solution for FX clearing which will reduce costs and complexity for the FX industry.”

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