Quick Takes: FX Clearing – What happens in March stays in March?!
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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: Hey Ali, how you doing? 

Ali Curi: I'm 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: I've already been warned on time, and I should highlight that I am going to talk about one of my favorite topics. The headline on the blog is "FX Clearing: What happens in March stays in March?!"

And as regular listeners will know, we've built up quite a backlog of blogs over the years now, and I was looking back and the first time I blogged on FX clearing was in 2016. If you look at the numbers, like FX clearing in 2016 wasn't even really a thing. It was absolutely tiny. And now, when I go back and look at the successive blogs, we probably write about FX clearing two or three times a year.

It's not so much a regular series. But we just try and stay on top of the trends. And I think if I was to summarize those early blogs, nothing happened in FX clearing until the uncleared margin rules came in. The uncleared margin rules pretty much were an economic mandate for NDFs to start clearing. So around about March of 2017, we started to see monthly volumes of NDFs of about $500 billion dollars a month. I think. And so then as each wave of uncleared margin rules has come in, as each wave of clearing mandates has come in, which there isn't a clearing mandate in NDFs, right? So even though clearing mandates have extended by jurisdiction and geography, all of those clearing mandates are in rates and credit.

There has never been that kind of kick on that, there is become a clearing mandate in NDS. There was definitely a lot of chatter about that back in 2017, but always the question in FX will, has been, will other stuff start to clear as well. So you've got physical FX forwards. You've got FX options as well.

Physical FX forwards are exempt from bilateral margin. And so they don't have the same margin overhead as NDFs do under the uncleared margin rules. But FX options do attract uncleared margin. And so a lot of our monitoring has been, "Hey, look, an NDF clearing has made another record." But I would say until I wrote this blog. There was never really anything significant to say about other products and at a high level, when you go back and look at the trends of volumes, so I have volumes going back all the way to 2016, I think, we see a very particular pattern of volumes for the past five years. And that is in every single March of 2020, 2021, 22, 23, and this year, there have been record volumes of cleared FX products. And it's really weird. It's always March, March is always a record. And the March volumes are always a record compared to the previous March. And I looked at it and I was like, well, I can't think of any particular reason why trading in FX products should spike in March, then I did a little bit of research and what I think it is related to is actually the uncleared margin rules.

Because the uncleared margin rules, you are only captured by those rules, if you have average aggregate notional amount over a certain calibrated amount, and that calibration period starts in March of each year for the US, Europe, and Japan. So my assumption is that NDFs of some kind are captured by this.

There is obviously some jurisdiction where a couple of big players are captured by this, and they're trying to clear them. So that they don't show up as uncleared trades, but that doesn't necessarily follow into other months as well. That's the only reason that I can think of that March is always a record month.

So that's kind of one interesting thing for the data from a high level. I would say the thing that's changed this year is now, dare I say it, FX options clearing is actually a thing. April of 2024 saw volumes of $200 billion dollars, basically, so FX options are now a bigger market than when we first started writing about FX clearing back in 2016.

And it means that NDFs only make up 85 percent of total FX volumes. Whereas last year that was something like 95%. So it really has been a significant acceleration in the use of clearing of FX options. If I put a little bit more context on that data, the clearing of all FX options is now as big as the clearing of Korean Won NDFs, which is the third largest currency.

So it's really been like adding another top three currency. So a real significant uplift in volumes. And then finally, what I wanted to do was compare that OTC market landscape to what's happened with FX futures as well. And this is a very short, short summary. Basically over the past year, nothing's happened in FX futures clearing.

Volumes are pretty static. What that means as a result is now that the open interest of cleared OTC FX options is now larger than the open interest of FX futures. Now that's not a fair like-for-like comparison because we're not talking about OTC, which has been compressed and optimized, et cetera. It's always the case that in the early stages of a market the open interest in OTC will grow a lot quicker. And we see that for NDFs as well in the open interest for NDFs grows and grows and grows throughout the year. And it looks like there's only a compression cycle run once a year for NDFs because open interest only drops once a year in December, which is classic end of year balance sheet window dressing. So those are the four things I wanted to point out. Amir, it's always been me that's written the blogs on FX, I think. Any specific questions that have built up over eight years worth of reading my blogs? 

Amir Khwaja: I guess it is your favorite subject, yeah, FX? 

Chris Barnes: It is, yeah. 

Amir Khwaja: I feel I can't really step into that.

But I'll tell you what I'm really interested in is that options, yeah. I guess we always thought that the swaptions would be the first product. And that never happened. So it's great to see FX options starting to clear in quite large size. And we've gone up from under $40 billion from your chart in early 2022 to $200 billion this year.

So that's almost a five x increase. But if I look at SDR volumes, which is US persons only. For April, I see more than $1. 2 trillion notional FX options, right? So again, we're still a small percentage and that's just the U. S. person's activity. So it excludes what's in Europe, which is probably as large, if not much larger.

Do you see a trend where do you think it can end up? That's the first question. And the other question I'm interested in is on your charts, why haven't the FX forwards gone up in the same way? Because I assume these FX forwards are really there to delta hedge these FX options. Because they're exempt. Two things, right?

Chris Barnes: I think those two questions are one in the same thing. To me, it is exceptionally weird that FX options have started clearing before swaptions. If you think about swaptions, the delta hedge of a swaption has a clearing mandate. And so you've got a bifurcated book whereby your delta on your swaption lives bilaterally, has to be optimized, or backed into clearing somewhere, and your delta hedges have to be cleared.

For FX options, there isn't a clearing market for FX forwards, unless they're related to Delta hedges of the FX options that are cleared, i. e. a tiny portion of the market. And so what is the rationale for sending FX options in? It feels more like, you know, The two ecosystems have almost chosen different paths from an optimization viewpoint.

There's rates whereby they want to sweep Delta related to swaptions into the clearing house. And then there's FX options that want to sweep multilaterally netted bilateral risk into the clearing house. It's kind of two different processes whereby one, you've got the Delta moving and the other just trying to find risk neutral portfolios that may go in.

I must admit, I've never spoken to the likes of Quantile and Trioptima as to exactly what the differences are between their FX options runs and their swaptions runs, but I think the data is telling us there's something fundamentally different about the optimization point. 

Amir Khwaja: Yeah, and I guess the other thing is I assume much of the clear FX options volume at LCH is dealer trading, yeah? Dealer trades. A lot of volume in SDR on FX options is on single dealer platforms. Client to dealer, although there's substantial D2D volume as well, right? On D2D venues. But really there's larger volume on dealer to client and single dealer platforms. 

Chris Barnes: But you would think equally that hedge funds would be big drivers of clearing for both FX options and swaptions.

It must be cheaper to clear than to use a prime broker. I would think.

Amir Khwaja: Great. Thanks, Chris. 

Chris Barnes: Ali, on that point, I will hand back to you. And as promised, I overran in time. Apologies. 

Ali Curi: No apologies necessary, Chris, thank you. And please, share with us again the title of your blog post. 

Chris Barnes: It's called "FX Clearing: What Happens in March, Stays in March?!"

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: Thanks, Ali. Always a pleasure. See you next week. 

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

Thank you for joining us.