Maximilian Dannheimer
What is an FX exchange for physical (EFP)?
Maximilian Dannheimer: It’s a transaction whereby you simultaneously execute an FX futures contract and an over the counter (OTC) transaction in the opposite direction. It’s a swap type of transaction, involving an OTC and on-exchange traded futures leg. The OTC leg is bilaterally negotiated and can be customised according to OTC market conventions, while the FX futures leg is a standardised instrument traded on the regulated exchange Eurex.
David Holcombe: The EFP is a basis market between OTC and listed FX. There are different perspectives on why you would trade EFP. Active traders most often consider it a spot to international monetary market (IMM) swap with the far leg centrally cleared, while on the buy-side it is a translation layer between OTC and listed FX – a tool that lets you use OTC liquidity and meet non-standardised value dates, while still running futures positions to secure the benefits that central clearing brings.
What are the benefits of using an EFP?
DH: While you can always trade FX futures outright on the exchange or bilaterally as block transactions, EFPs enable firms to access the much larger global pool of FX spot liquidity in search of price improvement or greater size, while still getting all the benefits of a cleared FX futures position.
The transaction itself is pretty similar to the standard OTC practice of rolling a spot execution into a forward position with your bank, but the multilateral netting you get from a cleared futures position means that with an EFP you have a single line to service per currency pair, per month/quarter, rather than one line per forward, per date with each bank that you’ve executed against.
MD: This ability to tap into the two different pools of liquidity is why EFPs are so attractive to US-based commodity trading advisors (CTAs) and, increasingly, European asset managers. There’s also a capital efficiency consideration here too. By essentially moving OTC positions into clearing, EFPs can help firms to manage the level of their uncleared derivatives exposures to ensure that they remain below the threshold at which they need to start posting bilateral margin with trading counterparts under the Uncleared Margin Rules (UMR).
You mentioned that European asset managers are increasingly looking towards FX EFPs, what do you think is driving this?
MD: I think that this is just part of an overall trend amongst this community towards listed FX trading, which is being driven by multiple factors. Many more of these asset managers will come into the scope of UMR in September later this year and look to mitigate the impact of these rules with cleared solutions. These firms are looking for firm FX liquidity sources with no last look to supplement their existing execution channels. These trends are occurring at the same time that Eurex has emerged as the European listed trading venue of choice, offering a wide range of on-exchange and centrally cleared FX products, including EFPs.
David Holcombe
DH: With FX futures offering firm liquidity as well as relationship trading models with highly transparent pricing, and with clearing allowing you to face new counterparts without the need for new bilateral credit or settlement relationships, asset managers in Europe are realising that these products are a great way to deepen their liquidity pool.
How exactly does the relationship between Eurex and 360T work for EFPs?
DH: Today the OTC market for EFP transactions is still largely using voice or chat channels. When 360T clients use our trade negotiation and execution tools for Eurex FX futures, whether that is accessing the central limit order book (CLOB) or off-exchange trading via any of our models, they enjoy straight-through-processing with Eurex that avoids all the booking errors and delays so common in manual trading processes. For FX futures relationship trading models in 360T, the key benefit for EFP clients is of course the ability to put multiple liquidity providers in competition for each order – greatly simplifying their best execution burden.
MD: It’s a very seamless process, and at Eurex we’ve also simplified the reporting process for FX EFPs to further streamline this trading activity. While we encourage our clients to make use of the various benefits on 360T for their EFP execution, we do not constrain where the OTC leg of the EFP has been executed. For Eurex it’s simply another transaction being reported, where we clear and process the FX futures leg.
Do you see this growing interest in EFPs as an indication that the divide between OTC and listed FX markets is narrowing?
DH: The dye is cast – the electronification of the EFP market has begun. 360T already has a streaming model for off-exchange block liquidity for Eurex FX, and a clickable ‘translation layer’ of readily available EFP pricing to move between OTC and listed FX is already an agenda item with many makers and takers.
MD: What’s really important here is that there are symbiotic growth trends at play. The deep liquidity of the OTC FX market is complemented by the benefits associated with a listed FX market which provides capital, netting and counterparty benefits to warehouse risk, and hence enhances firms’ FX trading capabilities as a whole.
How do EFPs fit into Eurex’s broader FX offering?
MD: Eurex has now succeeded in building up a liquid listed FX pool and gained commitment from various liquidity providers (LPs) who facilitate highly competitive prices and from the global clearing member community supporting access. On top of this we have continued to innovate, extending our Scandinavian currency offering and agreeing a partnership with the Korea Exchange (KRX) to list some of its contracts during European and North American hours.
All of this contributes to supporting our market models including on-screen trading, OTC block trading — which is bilaterally negotiated and then submitted for trading and clearing with Eurex – and EFPs. EFPs perfectly promote Eurex’s product suite as they enable clients to use multiple execution models combining exchange traded derivatives (ETD) and OTC FX markets so they can benefit from the best of both worlds.
