Quick Takes - NDF Clearing – The latest updates
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Ali Curi: Hi everyone. And welcome to ION Markets Quick Takes. I'm Ali Curi, and every week, along with my guests, Amir Khwaja and Chris Barnes, we take a quick dive into the headlines on the Clarus blog. Let's get started.

Hi, Amir. Hi, Chris.

Amir Khwaja: Hi, Ali. 

Chris Barnes: Hi, Ali. How are you doing? 

Ali Curi: Doing great. Welcome back to Quick Takes.

Chris, let's start with you. What's your Quick Take for this week? Which headline from the Clarus FT blog would you like to discuss? 

Chris Barnes: Thanks, Ali. This week, I'm going to be talking about NDF clearing. I think it's a really relevant subject now, because when you look at the two biggest markets, which don't have a clearing mandate yet, number one is FX. And number two is US treasuries. As we've mentioned on the podcast and on the blog previously, there's a clearing mandate coming in for US treasuries. And so I think it's really important to look at the evolution of markets, which don't have a clearing mandate in. And kind of compare it, right? We go, there's a clearing mandate in treasuries now, volumes have gone bang, "how big is it?" "What was a similar thing look like for FX, for example." And so we keep on benchmarking these products, which don't necessarily have a clearing mandate in place. Earlier this year, I think on the podcast and on the blog, we looked at NDF clearing holistically. So we looked at both your, let's say traditional NDFs where FX clearing has mainly been focused.

And then we said, "Oh, hold on. There's also the beginning of clearing in physical products." So FX options and that underlying delta hedges have started to be cleared in meaningful size this year as well. This blog doesn't look at FX options and the physicals at all. We're only talking about NDFs. The reason we're talking about NDFs this time is that the CFTC issues a weekly swaps report.

Now there's a load of blogs on the Clarus website about this CFTC swaps report, because the data behind it is quite tricky to reconcile. I think I'm right in saying it's because the observation period runs something funny, like Tuesday to Tuesday. There's something about the precise observation period that makes it a little trickier to reconcile the data, broadly speaking, when we've run what the CFTC reports as NDF total market, NDF cleared market, compared it to Clarus data, we are able to get into a broad brush reconciliation with that data. Because data keeps on changing in the background, there are changes to data standards and how the data has been reported.

The CFTC swaps report hasn't been published that reliably. So for example, I got the email end of September, the CFTC swaps report has been published. I think according to my data, that's the first one this year. I think it was published last, at the end of last year. So we've had that nine months where the CFTC data has not been available.

I'm particularly interested in this data because traditionally, when we've looked at it, it has given us a clearing rate for NDFs. So we're talking about Brazil, for example, here of somewhere between 25 and 30%. We're basically saying about a quarter of the NDF market is cleared. If you think broadly speaking, most markets are split 50/50 dealer clients. It's mainly dealers who clear. Therefore you're saying roughly half of the dealer-to-dealer market is cleared for NDFs. Back at the end of 2021, the CFTC did a rewrite of the CFTC swaps data. They said that they removed, let me get this right, they removed a lot of duplicative records. They removed a lot of inter-affiliate records and they did more extensive tracking of life cycle events.

What those changes appeared to do to the CFTC data is drastically drop the clearing rate of NDFs. So that ever since the end of '21, we now see a clearing rate of about 15%. The clearing rate almost halved as a result of those data changes. And I've tracked it through 2022 and '23, and it's been pretty consistent of 15%.

So I was super interested to see where the latest print for that was. And it was the same. It's roughly at 15%. So I'm not sure exactly what has happened, whether it means that there's a lot of internal clearing of NDFs. I feel like that would be a strange choice because you'd then be posting initial margin to a clearing house when they're internal trades only. And so you shouldn't really care about the credit risk. 

It's a really difficult one from a data perspective to unpick. It makes it a more interesting blog, because to be frank, in terms of the data, we see a consistent split of volumes. Volumes are increasing for sure, but generally you've got 22% in Taiwan dollar, 22% in INR, you drop a little bit to 20% in Korea, then down to 12% Brazil and the others 5% or less. It's an interesting one to follow. The other thing to note is that open interest is growing. So we're now over $2 trillion dollars in open interest. NDFs are traditionally short dated, average maturity of maybe one month.

So that's a bit of a different metric to when you talk about swaps markets, which are long dated. Therefore open interest, if you haven't got any compression can grow very, very quickly in swaps. For NDFs, you're of course, maturing very, very quickly, and so you need that new volume coming in as well. So we're definitely seeing more risk going into clearing houses in terms of effects.

I just think what will be really, really interesting over the coming months is when you talk about an open interest of $2 trillion dollars in NDFs as a record. I've been writing about this since 2017. So it's taken us seven years to get that right. You think about the clearing mandate for US treasuries, it's very likely that day one, they'll be way over that. It's probably an open interest DTCC of clear treasuries over that already. I'm not sure I haven't started to look at that data yet, but it really helps to put things in perspective, I think. Final thing I wanted to say is that in our Clarus data, we don't split the NDF volumes between dealer and client because the public data from LCH is only a single figure.

But if you zoom in on the LCH website, on the ForexClear website, there's a tiny chart, a really small chart, and it shows you the client volumes. It's good. Client volumes are growing. Looking at chart now, I'd say that client volumes have just reached a $100 billion dollars a month. That's a milestone. That sounds great. But when you look at the number of client trades versus the total, it looks like client clearing is still only accounting for about 3 or 4% of trades. So it's still a really interesting market to look at with that lens on because it's really a dealer product still. On that note, Amir, any specific questions for NDF clearing?

Amir Khwaja: Thanks, Chris. Yeah. I guess in the last quarter we saw much higher volumes, increase in open interest. And I can see from your charts that LCH ForexClear has now hit almost $11 billion FIM, up from $8 billion from the prior quarter, right? So we are seeing more risk. But still a low level of client NDF clearing.

And I'd imagine that the uncleared market is probably as big on the client side, as the dealer side, if not larger. 

Chris Barnes: Agreed. 

Amir Khwaja: I think we would expect some point the client IM or the client volume to start growing faster than the dealer volume at ForexClear. Would you agree with that? 

Chris Barnes: At some point, I think you also have to think about the impact of the uncleared margin rules here.

The uncleared margin rules acted as an economic mandate for dealers to clear because NDFs what were captured. Of course, for the clients, it really depends which of those clients in those jurisdictions are captured by the uncleared margin rules. And so if a lot of the end user clients, which you would expect like corporates are exempt from those rules, they don't have the same economic mandate to clear. That equally makes it more and more difficult for dealers to run, let's say, a matched book in clearing as well, right? It's beneficial for dealers to be able to net as much as possible at a single CCP. I still find the general outlook for client clearing for NDFs in particular as somewhat unclear, I think.

Amir Khwaja: Great. Thanks, Chris. 

Chris Barnes: No worries. Ali, I think that's time for today. That was my blog on NDF clearing. I have written a number of these. If you go on the Clarus website, there's a topic tracker. If you look under FX Clearing, we've written 47 blogs in total so far. 

Ali Curi: And thank you, Chris. Please share with us again the title of your blog post.

Chris Barnes: That was "NDF Clearing — The latest updates." 

Ali Curi: Great, that works. Amir Khwaja, Chris Barnes, thank you both for sharing your Quick Takes. Let's do it again next week. 

Amir Khwaja: Thanks, Ali. 

Chris Barnes: Look forward to it, Ali. 

Ali Curi: And that's our episode for today. You can read more about these topics on the Clarus blog, and you can follow ION Markets on X and on LinkedIn.

Thank you for joining us.