Futurization Comes to Europe

By David Wigan

Several exchanges are preparing to launch an array of futures in the coming months aimed at participants in the European swaps markets. With mandatory clearing requirements set to take effect later this year, the exchanges believe swap futures may appeal as a more capital-efficient alternative.

urex led the way in September, the possibility of listing swap futures on charge and more stringent measures for mea- launching a range of euro-denom- CME Europe, its London-based subsid- suring default and credit migration risk. Einated futures similar to the deliv- iary, sometime in 2015. Last but not least, Regulations also call for higher initial ery swap futures introduced in the U.S. the London Stock Exchange reportedly margins for OTC products compared to by CME Group just over two years ago. has begun talks with a group of banks exchange-traded futures. require- More recently Eurex signed an agreement about launching a European swap future. ments for swaps are based on the amount with Global Markets Exchange Group to No details have been disclosed by LSE, of risk over a time period of five days for license its design for a “constant ” but industry observers speculate that LSE cleared swaps and 10 days for uncleared interest rate swap , and aims to the large amount of inter- swaps. In contrast, the time horizon for said it plans to offer access to the GMEX est rate swaps outstanding at its subsidiary measuring the risk of swap futures is just product through its trading platform. LCH.Clearnet. two days. In December Intercontinental Exchange Another key attraction is standardization. jumped into the ring, announcing an Why Swap Futures? Like other futures contracts, the new swap agreement with Eris Exchange to license its Why the sudden interest in swap fu- futures offer the operational efficiencies of a methodology for swap futures. Eris has cre- tures? The key attractions of swap futures standard contract design. Two contracts that ated a market for swap futures in the U.S., are lower capital requirements and re- offset each other can be netted out through and the partnership will bring the Eris duced margins. clearing, and the processing of trades is model to Europe via ICE’s infrastructure. Under the Basel III capital standards that greatly simplified. CME is also targeting the European are now coming into force around the world, There is no standard approach to con- market. It has introduced a euro-denom- banks are confronting increased capital re- tract design, however, and the market will inated version of its deliverable swap fu- quirements for their OTC derivatives, aris- be faced with a diverse array of compet- ture on its U.S. platform and officials have ing from higher risk weightings on trading ing products with significantly different indicated that the exchange is exploring activities, a new credit valuation adjustment characteristics.

40 Futures Industry | www.fia.org Details of European Contracts designs developed by Eris—standards and be able to offer netting of margin require- The deliverable swap futures contracts flexes. Standards have quarterly expirations ments for users of its forthcoming credit offered by Eurex have physical settlement, based on the standard calendar used in the swap futures. meaning that when these contracts expire, interest rate futures market; the flexes allow In the rates market, the situation is more the positions settle into the underlying in- users to customize the maturity to any date complex and each of the major contenders terest rate swaps. In other words, an asset out to 30 years. The ICE contracts will be offers a different margin netting opportu- manager that goes into the with denominated in euros and pounds sterling, nity. Eurex is the dominant player in fixed a long position in Eurex 10-year Euro Swap complementing the existing Eris dollar- income futures thanks to its bund, bobl contracts at expiration will receive a 10-year denominated contracts that trade on Eris’ and schatz contracts. ICE is the dominant interest rate swap. Eurex offers contracts own platform and clear at CME. player in the short-term interest rate futures thanks to its acquisition of Liffe and that with maturities of 2, 5, 10, and 30 years, Modest Success in the U.S. with physical delivery into a plain vanilla exchange’s STIRS complex. LSE has no euro denominated interest swap with the Despite the perceived benefits of swap share of the market for interest rate futures, corresponding maturity. futures over traditional swaps, the actual but the SwapClear service offered by its The GMEX interest rate swap futures demand is far from certain. The Euro Swap subsidiary LCH.Clearnet is the dominant contract is constructed in a very different contracts launched by Eurex in September clearinghouse for interest rate swaps. way. The contract does not have a fixed have no , an ominous sign Recognizing the potential benefits of expiration; instead the contract is revalued given the exchange’s large customer base in offering margin netting across all three sets daily so that the maturity remains constant. Europe. Even in the U.S., where the Eris of products, Eurex is working to improve “We are offering annual maturities from two to 30 years, and the maturities are sticky so a 10-year today is 10-year tomor- row,” said Hirander Misra, the company’s Despite the perceived benefits of swap founder and chief executive officer. “The way you can is through weighted contracts in different maturities.” futures over traditional swaps, the Under the terms of the agreement an- nounced in December, trades in the GMEX actual demand is far from certain. contract will be arranged on GMEX’s trad- ing platform, which is regulated in the U.K., and then executed at Eurex, with clearing taking place at Eurex Clearing. In effect, this means that Eurex members will and CME contracts have been live for more the competitiveness of its clearing service have access to two types of interest rate swap than two years, the contracts have achieved for interest rate swaps as well as the ease futures—deliverable and constant maturity. only modest success so far. of trading STIRS on its platform. Eurex ICE is planning to offer two sets of During the quarterly rolls, volume in has updated its trading system with signifi- swap futures based on the Eris methodol- CME’s deliverable swap futures has reached cant short-term interest rate functionality, ogy. One set will target the credit default as high as 61,000 contracts traded in a single including packs and bundles as well as swap market; ICE said it will list swap fu- day, but normally the daily volume is below strips, butterflies and condors as bespoke tures based on benchmark CDS indices 10,000 per day, and volume at Eris has been strategies. in both the U.S. and Europe. These new about half that. On the other hand, both ex- “Investors trading our Euro contracts will supersede a previous effort changes report that open interest has been futures, OTC cleared swaps and new inter- by ICE to create a CDS swap futures con- rising steadily, an indication that customers est rate futures will be allocated one margin tract that failed to gain traction. This time are increasing the number of contracts being bucket, so the efficiencies are pretty clear,” around, the contracts are designed to offer held in their accounts. Open interest at year- said Stuart Heath, executive director and clients “the regulatory certainty of futures end was approximately 125,000 at CME head of the Eurex representative office in without compromising traditional OTC and 140,000 at Eris. the U.K. “Clearly market participants need to evaluate where it would be cheaper on a characteristics,” ICE said. These include the Portfolio Margining inclusion of “price alignment interest,” an trade by trade basis, and it depends on their adjustment to the value of the futures con- In Europe, one of the keys to success positions, but end-users probably stand to tracts that mimics the cash flows on tradi- will be portfolio margining–the­­ ability for benefit considerably.” tional OTC swaps. clients to reduce margin requirements via The other set will target the interest rate offsets from related instruments. In credit, ...... market. ICE Futures Europe will list inter- ICE is the dominant player in the clear- David Wigan is a freelance writer based in est rate swap futures based on two contract ing of OTC credit default swaps and it will Europe.

Futures Industry | January 2015 41