There are significant economic benefits from switching from traditional OTC FX trading to FX futures, according to a new report from Greenwich Associates.
The new Greenwich Report, A Bright Future for FX Futures, concludes that, in many scenarios, futures are a cheaper alternative to OTC trades in the FX market, with savings reaching upwards of 75% in some cases.
Given the increased scrutiny that buy-side traders are placing on trading costs, along with regulatory schemes such as Basel III, which will likely drive execution costs higher, FX futures are a product that traders need to consider, said David Stryker, Principal with Greenwich Associates Markets team, and author of the report.
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 than it has been in the past.. For others, they may find that they are getting de-prioritized and receiving fewer services from particular counterparties altogether. As a result, adding the option to trade in a futures environment could help mitigate the effects of shifting sell-side behavior.
Why Not Futures?
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 of the amount of liquidity available in an exchange-traded environment. As investors begin to see the evidence of the growth in FX futures and the fact that recent data shows that ADV in FX futures equals or exceeds the volume on a major spot exchange, we expect some of the concerns around liquidity to diminish, says David Stryker.
A Bright Future
Greenwich Associates expects liquidity in the futures markets to continue to grow, making it progressively easier to trade FX on an exchange. Meanwhile, given the pressure that the sell side is facing to meet capital and return requirements, Greenwich Associates expects the implicit cost of trading OTC FX to rise in the coming years.
Over the short and medium term, FX futures will continue to gain traction, says David Stryker. Our analysis proves that even before considering the potentially punitive effect that regulations have on trading costs, trading FX futures makes clear economic sense.