A Bright Future for FX Futures
Getting investors to change their trading habits requires both education and demonstrable economic incentives.
In the face of the growth in FX futures trading, Greenwich Associates set out to examine and assess the potential economic benefits of utilizing futures as an alternative to trading in the OTC markets.
To do so, we employed a proprietary quantitative model to analyze the costs associated with trading FX over-the-counter (OTC) against comparable FX futures. The model calculates the cost of opening, maintaining and closing out a position. To validate key inputs into the model and gather feedback on current demand and pricing, we spoke with FX traders on the buy and sell side.
The results show that FX investors can find significant cost savings (upward of 75% in some cases) by trading futures rather than executing a trade in the OTC markets. For those entities subject to Basel III costs, switching to futures from OTC trades could garner even greater savings.
Pure costs savings are not the only reason to consider FX futures. As sell-side dealers become more selective in the clients that they prioritize, some buy-side traders may find liquidity more difficult to access. Others may find that they are getting de-prioritized and receiving fewer services from particular counterparties. As a result,madding the option to trade in a futures environment could help mitigate the effects of shifting sell-side behavior.
Even with these potential cost savings, a switch to futures might not make sense for some FX market participants that trade only infrequently and at relatively small volumes. And for some investors, there may be lingering skepticism about the available liquidity in an exchange-traded environment, even though recent statistics show that average daily volume (ADV) in FX futures equals or exceeds the volume on a major spot exchange.
The results of our analysis prove that even before considering the potentially punitive effects that regulations have on trading costs, trading FX futures can have clear economic benefits. For that reason, we expect FX futures to continue to gain traction as an alternative to OTC trading.
With over $5 trillion of volume transacted on any given day, FX is far and away the largest and most liquid financial market in the world. Participants in this market range from asset managers with AUMs measured in the trillions to large multinational corporates to individuals making a few speculative trades per year. Therefore, any structural changes to the market, whether driven by competitive forces or regulatory pressures, could have a wide range of consequences.
In many different asset classes, the introduction and adoption of futures has had a material impact on investors’ trading habits. However, changing investor behavior is not as simple as introducing a new product and expecting change overnight. Instead, inertia is often the name of the game, and overcoming it requires both education and demonstrable economic incentives.
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