CME Group was asked by clients in December of last year to deliver a compression service for clearing OTC FX Non-Deliverable Forwards (NDFs). In response, the exchange has made tremendous strides to accommodate the demand of its users, by creating a tool called FX blending.
Regulations around the world pertaining to global derivatives have increased the focus of financial institutions on maintaining capital margin requirements. While NDFs are not technically required to be cleared by global regulatory confinements, there is still a considerable impact on them, thereby providing incentive and advantages for those who do clear NDFs.
The advantages brought forth by enabling clearing capabilities for NDFs have led to increased demand by CME clients, leading them to request the creation of the compression tool.
Advantages of Voluntary Clearing of NDFs
CME clients appear intent on taking the advantages of the compression tool. Clearing NDFs helps to aggregate positions into a single account, thereby enabling margin netting, which substantially lowers the margin requirements of a portfolio. Holding positions in a single account enables the compression of the portfolio and the trades that it encompasses.
Moreover, by the reducing the gross notional outstanding in a portfolio, clients benefit from an improved leverage ratio.
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FX Blending and its Benefits
FX blending reduces the notional outstanding and line items of an NDF portfolio, as a result of fewer trades in the account, while simultaneously maintaining the same level of risk of the portfolio that existed prior to the compression.
The reduced number of trades in the portfolio reduces the gross notional, which benefits both the buy side and sell side of a position. During the FX blending process, the CME tool identifies the highest and lowest prices of NDFs that exist within the portfolio.
The tool is then able to calculate the weighted average and USD notional amount for each of the trades. Once the USD notional amount is established for each of the highest and lowest priced positions, the tool is able to further calculate the sum notional of FX blending, and assure that this number equals the notional value of the portfolio.
In other words, after the blending has been completed, the overall risk level of the portfolio remains constant, despite there being fewer trades, leading to a gross notional reduction in the account.
CME Group continues to move forward with agendas to improve its operational capacity. Earlier this week, Finance Magnates reported that CME Group is considering placing a bid in a quest for a takeover of NEX Group.
As evident by the introduction of the compression tool, CME Group is able to consider the input of outside sources, in an effort to improve the overall functionality. Another example is CME’s recent entry into blockchain technology, amid the growing global demand for cryptocurrencies. Blockchain technology has many advantages, and it appears that the CME is ready to adjust to the new technological capabilities.