LONDON, March 13 (IFR) - The CFTC has given the green light for US investors to trade Total Return Futures linked to the EuroStoxx 50 - a move that could prove pivotal in building liquidity and cementing the Eurex-listed contracts as a viable alternative to over-the-counter equity swaps.
The instruments have already made their mark in Europe with more than 83,000 contracts traded since the December launch, representing €2.8bn notional. Volume has more than doubled in the last month as new users jumped on board, extending the market beyond the bank hedging activity that initially dominated trading.
"We have seen more buyside involvement and have been surprised to see a growing number of strategic trades such as calendar spreads," said Stuart Heath, director of product R&D at Eurex. "The US approval will be very good for current participants as it extends the range of users to US directional and global macro accounts, which can use the TRF to do longer-dated trades."
While the latest approval opens the door to the largest pool of global liquidity, the contribution of US investors to the success of European products depends on global macro views of European equity markets.
"At the moment, Europe is a big focus for a lot of US investors as many view the market as underpriced to the US, so it's a very good time to offer the product," said Heath.
Some early adoption by buyside firms has raised hopes around the long-term prospects for the product. Through calendar spread trades, the contracts have enabled investors to gain exposure to implied equity repo - a measure of secured funding and a hidden parameter in any equity products including cash, futures, options and structured products. Equity repo has suffered severe dislocations in recent years as a result of uncertainty surrounding the impact of tighter regulations, including the Basel III leverage ratio and net stable funding ratio, on bank balance sheets.
“This innovative product and implied repo as an asset class in its own right represents an exciting opportunity for US-based market players in the equity derivatives space," said Emmanuel Dray, head of equity derivative institutional sales & linear trading at BNP Paribas, which jointly developed the contracts. "We are happy to be a lead participant in the development of the TRF on EuroStoxx 50 in the US."
Evidence from Eurex-listed VStoxx futures, which offer exposure to options-implied volatility on EuroStoxx 50, suggests that US approval can be integral for deepening liquidity in European products. Trading in VStoxx contracts more than doubled within a year of the CFTC's 2012 approval, which opened the door for relative value trades against the CBOE's ultra-liquid VIX futures.
Relative value trades could be possible with the Eurex-listed TRF, but a rival US product offered by the CME carries a different pricing format, requiring an additional layer of calculations to trade the two instruments. The CME's Total Return Index Future linked to the S&P 500 is quoted in index points, similar to listed futures, while the Eurex TRF is more closely aligned with OTC conventions and quoted in basis points over Libor.
For OTC equity swap traders, the Eurex structure makes for a smooth shift into the listed world. That could prove crucial in 2018, when buyside firms will be required to post initial margin on swaps exposures that are not cleared through central counterparty clearinghouses. Most financial counterparties will also be caught by variation margin requirements that became effective earlier this month, though global regulators provided a six-month grace period for implementation, meaning that all participants must comply by September.
For Eurex, establishing ample liquidity is the primary focus, but with the product already showing strong signs of defying a high failure rate for futures launches, development opportunities are already under consideration.
"There's certainly scope to extend the range and we're consulting closely with clients," said Heath. "It may be that five year maturities are not long-term enough so we could see extended maturities.”
The contracts could also be applied to benchmarks beyond the EuroStoxx 50, but Heath notes that the exchange intends to take a cautious approach to expansion, with careful consideration to underlying swap markets.
“The technology can be applied to other indices, subject to licensing, but it comes down to the structure of the OTC market, which differs depending on the index,” said Heath. “The EuroStoxx 50 has a big underlying structured products market with a lot of hedging demand, but that’s not the case with a lot of other indices.” (Reporting by Helen Bartholomew)