Analysis: Complex foreign exchange options not ready for prime time

Mon Dec 16, 2013 11:38am EST
 

By Gertrude Chavez-Dreyfuss

NEW YORK (Reuters) - Trading forex options on registered U.S. platforms is a long-awaited step in making derivatives markets more transparent, but so far it has failed to take off.

Rules became effective in October that required these trades to move to swap execution facilities, or SEFs. However, there is no established clearing-house for these trades, and with the additional paperwork and legal requirements needed to trade on SEFs, many market players are electing to stick with trading the old-fashioned way, that is, by telephone or on bank platforms.

Commodities Futures Trading Commission rules require FX options and non-deliverable forwards traded between U.S. entities to be executed on a SEF, the designated trading platform for regulated derivatives. However, that requirement will not fully be in effect until these FX products can be cleared. At the moment, there is no entity that can clear FX options.

Currently, the limited number of FX options traded on SEFs are being cleared and settled between counterparties.

Shifting derivatives trading to central clearing-houses was a key part of the Dodd-Frank Act that emerged after bad derivative bets contributed heavily to the 2008 financial crisis. The new regulations were meant to lower the risks of these products through greater transparency.

Eventually, the necessary structures to support SEFs will be built, and market participants say electronic trading on these platforms will increase. But for now, dealers see no urgency to use the SEFs because they are still untested.

"If you are a buyside (asset manager) and there is no mandate to trade on the SEF, why would you go through all the hassle of trading on that, when you don't have to?" said Tod Skarecky, senior vice president at technology provider Clarus Financial Technology in Chicago.

Daily U.S. activity in FX options amounts to $52 billion, including $23 billion through electronic systems. By comparison, FX options turnover on SEFs for the week ended December 6 showed an average of about $9 billion in daily trading, according to data from Clarus, which tracks SEF volume.   Continued...

 
A man walks past a display showing the exchange rates of foreign currencies in Zurich October 4, 2013. REUTERS/Arnd Wiegmann