FX Market and CNH Overview: Hedging risk and opportunities · PDF fileFX Market and CNH Overview: Hedging risk and opportunities ... mitigation mechanism 18 ... Largest traded Currency

© 2014 CME Group. All rights reserved.

FX Market and CNH Overview: Hedging risk and opportunities

May, 2014

Malcolm Baker

Senior Director

Head of Foreign Exchange and Interest Rate Product, Asia


• Shifting Environment in the Global FX Market: the Electronification

of FX Trading

• Evolution of FX Markets.

• Listed RMB Product Launches: How we got here, here we are

today, and where we are going tomorrow?

Agenda


The Shifting Environment in the Global FX Market:

The Electronification of FX Trading


What’s Changing: OTC FX Derivatives are Going through

a Global Regulatory Filter

4

1 2 3 4 Basel III BCBS/ IOSCO CPSS/ IOSCO Dodd-Frank/EMIR

Improved coverage of

counterparty credit risk

(CCR)

Margin requirements for

non-centrally cleared

OTC derivatives

Common principles for

CCPs

Mandatory central clearing

for standardized OTC

derivatives

• Introduction of CVA

• Refined treatment of

CCP exposures

• Introduction of leverage

ratio

• More stringent rules for

margin calculation and

segregation

• Subject to an exposure

threshold

• Guiding principles to

structure CCP risk

management

• Stress-test (Cover 1/2) to

size default fund

• Reporting of all derivatives

to trade

repositories

• Improved risk management

Drives capital

requirements

Drives initial margin

requirements

Drives default fund

requirements

Drives central clearing

requirements


• Today, FX is an OTC-driven market with primary price discovery occurring across

globally fragmented execution venues

• The average daily turnover of global FX markets is estimated to be $5.3 trillion1

5

Current FX market structure and landscape

Spot Swap

s

Forward

s

OTC FX

G7 Options

NDFs Emergi

ng

Exchange Traded

FX Futures &

Options

$160bn+2

$2,050bn

$680bn

$2,200bn

$340bn

$[100]bn

1 BIS, Triennial Survey April 2013 2 Daily notional turnover (2013 BIS and ClientKnowledge FX Market Research)

Peer Exchanges and

Clearinghouses

OTC Venues OTC Credit Intermediaries

ICE, HKEx, LCH, Eurex, Moscow,

BM&F, SGX (CME ~75% of ETD)

Single Dealer Platforms, EBS, Reuters,

Currenex, HotSpot, FXAll (acq Reuters)

(No single platform >$200bn)

FX Prime Brokerage Units and

FCMs

© 2014 CME Group. All rights reserved. 6

The Global FX Market Structure: Already Shifting…

Spot Swaps

Forwards

OTC FX

Options

NDFs

Cleared

G7 Emerging

Exchange Traded FX

Futures & Options

(ETD)

ETD 1

Convergence 2

Central Clearing 3

ETD are becoming even

more attractive, relevant and

appreciated in this changing

market landscape, growing

faster than OTC

OTC participants are seeking

cost effective ways to access

both ETD and OTC markets,

driving convergence through

e-commerce solutions

OTC markets are moving to

a centrally cleared model for

both exempt and non-

exempt products


FX market and RMB highlights*

7

FX Market ADV in April

2013

$5.3Trillion

Chinese Renminbi

average daily volume

$120Billion

41% Total daily market

turnover for Exchange-

Traded FX products

$160Billion

Global FX trading via the

UK

87% US Dollar remained the

dominant vehicle currency

Offshore Chinese Renminbi

average daily volume in

2014

$30*Billion+

* Bank of International Settlements, preliminary results April 2013, OTC FX traders’ market feedback


• Since 2012, the CNY and CNH

spread has narrowed significantly

• With the exception of recent spread

widening ahead of band widening

action, CNH traded at only a modest

premium to CNY

• Could increased 2 way pricing

encourage arbitrage and widening

of the CNY/CNH spread?

• From August 2010, CNY has

appreciated 9.4% vs USD and CNH

has appreciated 8.7% vs USD

• Some analysts recommend

USD/CNH is a better proxy for

USD/CNY spot than the actual fix

• CNH premium tends to be positively

correlated with market pricing of

future CNY appreciation

CNY and CNH spread

8


• Chinese renminbi internationalisation continues: PBoC widening USD/CNY band to +/-

2% in 2014

• Increased 2–way volatility in CNY propels increased hedging activity

• CNH volumes set to increase yoy as local corporates and traders migrate from CNY

NDFs to CNH spot/forwards adoption

• Increase usage of exchange-traded derivatives to hedge CNH as more exchanges

launch USD/CNH contracts

• Certain cross rate pairs like EUR/CNY, EUR/CNH, CNY/ZAR, CNH/ZAR, CNY/RUB,

CNH/RUB to grow, albeit off of small volumes

• CNH options overtake HKD options trading in January – a blip or sustainable trend?

• OTC cross currency swap liquidity to improve with increased funding in CNH by

corporates

9

What lies ahead for CNH hedging in 2014/2015?


Evolution of FX Markets:

The “Futurization” of FX


Pricing and transaction cost transparency

Centrally cleared counterparty risk mitigation

Concentrated liquidity into select settlement dates along the forward curve

11

Hedging with FX futures offers:


Futures v OTC Forwards

12

Futures OTC Forwards

Pricing

Transparent – listed

Liquidity

Central Order Limit Book

Tight Bid-Offer Spreads, especially front month majors

No/Limited Transparency

Fragmented liquidity across all dates

Price discovery via quotes from dealers

Potential for inconsistent, wide spreads in

less liquid currency pairs, particularly EM

Execution Quick Execution - average of less than 3 milliseconds per round turn

futures transaction

Straight-Through Processing (STP) through multiple clearing houses

Voice trading may incur time lags / delays

to execution

STP defined by counterparty readiness

Credit Mitigated credit and counterparty risk via central clearing house

No ISDA negotiation

Requirements known in advance of execution

Portfolio margining

Process depends from dealer to dealer

ISDA Negotiation

Varying credit lines / analysis over time

Potential credit charge applied to spread

Collateral / Margin Margin posted upfront via performance bonds (i.e. on 1 EUR/USD

futures (EUR 125,000) contract margin requirement = Initial =

$5,400, Maintenance = $4,000

Varying collateral / margin requirements

May require negotiation of CSA

Counterparty Risk Futures cleared via CME Clearing

Minimal counterparty risk

Depends on dealer as counterparty

Monitoring required as banks / broker-

dealers are expected to be downgraded

with continuing regulatory and market

pressures

Fees Known upfront costs on a per contract basis Costs include potential wider bid/offer

spreads, sales mark-up, and credit charge

Costs unknown until time of execution

Hedge Accounting Hedge accounting applies upon demonstration of hedge

effectiveness as per GAAP / IAS 39

Hedge accounting applies upon

demonstration of hedge effectiveness as

per GAAP / IAS 39


Coverage

• 61 FX Futures contracts

• 31 FX Options contracts

• 21 currencies

Contracts

• Physically-delivered (Majors)

• Cash-settled (Emerging markets)

• Settling on IMM dates for majority of currencies

Other products

• E-mini FX

• E-Micro FX

• Variance Futures

• $ index

Specifications

http://www.cmegroup.com/trading/fx/

CME Group (US) FX product offering on Globex

13

FX futures by currency (6m Average)


FX Futures: Significant Outperformance vs

the OTC FX Market

14

42%

80%

86%

101%

113%

114%

30%

40%

50%

60%

70%

80%

90%

100%

110%

120%

Q1 2007 Q4 2007 Q3 2008 Q2 2009 Q1 2010 Q4 2010 Q3 2011 Q2 2012 Q1 2013 Q4 2013

CME ADV as a % of EBS Q1 2007 – Q4 2013


FX Options: A Thriving Franchise

15

0.0

2.0

4.0

6.0

8.0

10.0

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

No

tio

nal V

alu

e (

in b

illio

ns o

f d

ollars

)

Av

era

ge D

aily V

olu

me (

in c

on

tracts

)

CME FX Options Average Daily Volume and Notional Value

with 12 month moving average

2013 ADV of 60,000 contracts or $8.2 billion in notional terms, +46% YOY


FX User Base: Diversified & Growing

16

0

200

400

600

800

2009 2010 2011 2012 2013 2014 2015

CME Group Foreign Exchange Futures Aggregate Number of Large Open Interest Holders*

Source: CFTC

Majors Emerging Markets

Change over Selected Periods

Last 4 Weeks Last 13 Weeks Last 52

*The CFTC defines large open interest holders as having at least 400 open contracts in

Major Foreign Currency futures and at least 100 open contracts in Other Foreign Currency

Change over Selected Periods

Last 4 Weeks Last 13 Weeks Last 52

Weeks

+58.3 +39.4% −25.9%

714

152


• Proprietary Firms

• Hedge Funds

• Pension Funds

• Arcades

• Currency Managers

• Asset Managers

• Brokers

• Banks (less than 10% of CME volumes, 30%+ of open interest)

• Commercials/Corporates

17

FX customer segments


• Electronic markets

- Improved price discovery

- improved liquidity & depth of book

• Growth of the buyside

- greater distribution

- diverse counterparties

- leading to greater volumes

• Central counterparty

- hedging/credit risk mitigation mechanism

18

Why the growth?


Listed RMB Product Launches:

How we got here, where we are today, and where we are going

tomorrow?


INR/USD Futures launched January 28, 2013

Cash-settled

Standard (5MM Lakhs) and e-micro (1MM Lakh) sizes, roughly $93k, $19k

Block-eligible with maturities out 3 years

Standard contracts: Based on USD 100,000

USD/CNH Futures launched February 25, 2013

Physically delivered

Quoted in standard interbank FX / European terms

Daily pays and collects in CNH

Block-eligible with maturities out 3 years

Standard and e-micro contracts: USD 100,000 and USD 10,000

USD/ZAR Futures launched September 23, 2013

Physically delivered, CLS-eligible

Quoted in standard interbank FX / European terms

Daily pays and collects in ZAR

Trades along the curve out to 2 years

Local South African bank market maker

20

BRICS products launch 2013


Kay product features - At a glance


• CNH Enhancements: RMB FX Futures Markets are still Maturing. Both CME Group’s USDCNH and other Exchanges listing USDCNH have experienced Delivery / Settlement concerns from Market Participants.

• A Cash Settled USDCNH based on TMA HK fix could be answer ?

• CNH FX Options Launch: CME plans to launch both short and long dated CNH FX Options in 2014. The CNH OTC options market has exploded to trading $30-50billion notional per day, according to some local OTC options traders. By offering CNH options in 2014, CME would be the first Exchange to list USDCNH FX Options.

• CNH/CNY Spread Contract: CME is planning to launch a CNH/CNY spread contract (implying from one to another through Globex.

• CNH/CNY We actually are seeing renewed interest in our Legacy CNYUSD contract for those looking to trade/hedge in the RMB market yet not wanting a Physically delivered contract. CME Group’s CNYUSD Open Interest has continued to grow despite the OTC markets focus on USDCNH in recent times. The Liquidity profile is much different from CNH to CNY OI. The majority of the OI in CNY sits in the front month with USDCNH OI sitting 9 to 12 months out.

• USDCNH Extraordinary Growth The recent BIS survey made the RMB the 10th Largest traded currency globally. Market players are describing an extraordinary growth in RMB in last 6 months and in Feb 2014, Reuters claimed it was their 2nd Largest traded Currency. On one day trading on their platform alone stood at $39billion in spot.

22

RMB FX Product Line 2014 for CME (US)


USD/CNH open interest


Spread of CME’s CNYUSD and USDCNH March 2014

contracts over 20 days; Last 20 days have provided a

trading range of 200 Pips between the two CME contracts


• Between Nov 11 and Dec 05 the Sep2014 Expiry (approx. 9 month) Trades in Range of

+200 to +300 and back down to -50 pips difference

• At the same time the March 2014 contract difference from a competing Exchange to

CME trades in a range of +/- 20 pips at widest

• Traders potentially could exploit these differentials utilizing Forward Forwards in a more

Capital Efficient manner. (Fwd fwd meaning Mar14/sep14 FX Calendar spread. Which

synthetically creates a IMM forward Dated Starting and Ending OTC USDCNH FX Swap

• A Plethora of Block Market Makers are available

25

CME USDCNH Sep 2014 contract versus a Competing

Exchanges similar USDCNH Sep 2014 contract


CME USDCNH Sep 2014 contract versus a Competing

Exchange similar USDCNH Sep 2014 contract spread

26


• CME Launched USDCNH FX Futures 25th Feb 2013.

• There are Two Contracts Standard USDCNH @ $100,000 Notional and a Micro @ $10,000 Notional.

• Only Exchange to offer 23 Hours a day Liquidity in USDCNH.

• USDCNH Launch complements the Existing CNYUSD Cash Settled Future. Current ADV around $25million Notional.

• 3 Designated Market Makers Obliged to Provide 30 to 60 Pips Bid Ask spread out to 12 months.

• Record Daily turnover $121 Million notional in 9 Month Part of Curve.

• Total USDCNH traded $1.36 billion Mainly in Back Dated ( deferred contracts )

• Block Market Makers Provide Liquidity Outside Globex in Larger trades.

CME Group (US) FX product offering on Globex

27

CME’s USDCNH Monthly Volumes

Since Launch

Product Month Volume Notional

CNH APR13 283 $ 28,300,000.00

CNH MAY13 10 $ 1,000,000.00

CNH JUN13 2449 $ 244,900,000.00

CNH JUL13 290 $ 29,000,000.00

CNH AUG13 212 $ 21,200,000.00

CNH SEP13 934 $ 93,400,000.00

CNH OCT13 275 $ 27,500,000.00

CNH NOV13 187 $ 18,700,000.00

CNH DEC13 2370 $ 237,000,000.00

CNH JAN14 161 $ 16,100,000.00

CNH FEB14 52 $ 5,200,000.00

CNH MAR14 1912 $ 191,200,000.00

CNH JUN14 3478 $ 347,800,000.00

CNH SEP14 1014 $ 101,400,000.00

TOTAL: 13627 $ 1,362,700,000.00


FX futures product on CME Europe

28

Major Currencies (CLS*-Eligible Physical Delivery)

Australian Dollar/US Dollar

British Pound/US Dollar

Euro/US Dollar

Euro/British Pound

New Zealand Dollar/US Dollar

US Dollar/Canadian Dollar

US Dollar/Japanese Yen

US Dollar/Swiss Franc

CLS*-Eligible Physical Delivery Currencies

Euro/Danish Krone

Euro/Japanese Yen

Euro/Norwegian Krone

Euro/Swedish Krona

Euro/Swiss Franc

US Dollar/Israeli Shekel

US Dollar/Mexican Peso

US Dollar/South African Rand

Non-CLS*-Eligible Physical Delivery Currencies

Euro/Chinese Offshore Renminbi

Euro/Czech Koruna

Euro/Hungarian Forint

Euro/Polish Zloty

Euro/Turkish Lira

US Dollar/Turkish Lira

US Dollar/Chinese Offshore Renminbi

Non-CLS* Cash-Settled Currencies

Euro/Chinese Renminbi

US Dollar/Ukrainian Hryvnia

US Dollar/Brazilian Real

US Dollar/Chinese Renminbi

US Dollar/Indian Rupee

US Dollar/Korean Won

US Dollar/Russian Ruble

*CLS stands for 'continuous linked settlement,' which describes the process whereby banks manage settlement of foreign

exchange amongst themselves and their customers, including corporates


Cleared OTC FX offering

29


Thank you. Any questions?


Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of

a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders

should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one

trade because they cannot expect to profit on every trade. All references to options refer to options on futures.

Swaps trading is not suitable for all investors, involves the risk of loss and should only be undertaken by investors who are ECPs within the

meaning of section 1(a)12 of the Commodity Exchange Act. Swaps are a leveraged investment, and because only a percentage of a contract’s

value is required to trade, it is possible to lose more than the amount of money deposited for a swaps position. Therefore, traders should only use

funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because

they cannot expect to profit on every trade.

Any research views expressed are those of the individual author and do not necessarily represent the views of the CME Group or its affiliates.

CME Group is a trademark of CME Group Inc. The Globe Logo, CME, Globex and Chicago Mercantile Exchange are trademarks of Chicago

Mercantile Exchange Inc. CBOT and the Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago, Inc. NYMEX, New

York Mercantile Exchange and ClearPort are registered trademarks of New York Mercantile Exchange, Inc. COMEX is a trademark of Commodity

Exchange, Inc. KCBOT, KCBT and Kansas City Board of Trade are trademarks of The Board of Trade of Kansas City, Missouri, Inc. All other

trademarks are the property of their respective owners.

The information within this presentation has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for

any errors or omissions. Additionally, all examples in this presentation are hypothetical situations, used for explanation purposes only, and should

not be considered investment advice or the results of actual market experience.

All matters pertaining to rules and specifications herein are made subject to and are superseded by official Exchange rules. Current rules should be

consulted in all cases concerning contract specifications.

Copyright © 2014 CME Group. All rights reserved.

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FX Market and CNH Overview: Hedging risk and opportunities · PDF fileFX Market and CNH Overview: Hedging risk and opportunities ... mitigation mechanism 18 ... Largest traded Currency