Benchmark Transition Spotlights Futures Trading

Shanny Basar

The transition from benchmarking sterling assets to the Libor index to the new Sonia index in 2021 presents an  opportunity for another exchange to potentially displace the Intercontinental Exchange as the dominant trading venue in short-dated sterling futures.

Chris Turner, analyst at German investment bank Berenberg, said in a report that $30 (€26) trillion  of assets are benchmarked against sterling Libor. However, following a series of scandals about investment banks manipulating the Libor rate for their own benefit, the index is being retired in 2021 and replaced by Sonia – the sterling overnight index average. The Bank of England took over as the Sonia administrator and began producing the rate on April 23 this year using transactions such as overnight unsecured transactions negotiated bilaterally, as well as brokers.

Turner continued that ICE currently dominates trading in sterling Libor futures.

“The transition to the new Sonia benchmark creates a rare opportunity for another exchange to potentially displace ICE as the dominant trading venue in short-dated sterling futures,” he added. “This is not without precedent: Deutsche Börse successfully used the disruption caused by the electronification of trading to ‘steal’ the Bund futures contract from Liffe (now part of ICE) in late 1998.”

Both ICE and rival London Stock Exchange Group have launched Sonia futures ahead of the transition. ICE Futures Europe launched a new three month, cash-settled Sonia futures contract at the beginning of this month following the introduction of a one month Sonia future in 2017.

Stuart Williams, president of ICE Futures Europe, said in a statement: “The introduction of three month SONIA futures complements our strategy to provide market participants with a broad range of tools for managing interest rate risk in a capital efficient manner. ”

CurveGlobal, the LSE Group’s derivatives venture with a number of dealer banks and the Cboe, had launched a three  month Sonia future contract in April.

Andy Ross, chief executive of CurveGlobal, said in a statement: “With the launch of the CurveGlobal three month Sonia Future, we’re helping to make the transition of sterling portfolios to the new Sonia benchmark as smooth and simple as possible. Our clients will now be able to trade more efficiently and cheaply, using accurate, transaction-driven pricing; hedge their positions more easily; and benefit from reduced margin payments.”

At the same time CurveGlobal also introduced the Inter Commodity Spread between the CurveGlobal three month Sonia future and three month sterling future. The exchange said this enables cross-market trading with no legging risk.

Turner estimated that sterling futures generate revenues of $85m a year for ICE, implying that short-dated sterling futures are an $850m opportunity.

“Although modest in size, traction in Sonia futures would also make it easier for LSE to move into other listed derivative contracts (particularly Euribor futures),” he added.

However Turner also said that most participants are likely to still find it more efficient to net Sonia contracts with their existing book of derivatives at ICE rather than at LCH, the LSE’S clearing house.

“Via CurveGlobal, LSE is currently offering free trading and clearing in Sonia futures, as well as providing equity incentives to trade (a so-called ‘jump ball’ programme),” Turner said. “The economic incentives of many market participants may not align perfectly with margin efficiency as a result.”

The need for market participants to develop new cash products and liquidity in derivatives and futures referencing the new risk-free rates was highlighted as one of the key issues for a successful transition in a survey published yesterday by a group of financial trade associations.

Simon Lewis, chief executive of the Association of Financial Markets in Europe, said in a statement: “In Europe, there are €1.2 trillion of outstanding securitizations, many of which are linked to an IBOR and will revert to a fixed rate if this IBOR ceases to exist before the maturity of the bond, causing significant changes to future cash flows.”

The survey found that 78% of participants expect to trade risk-free rates within the next four years, although preparations are at an early stage.


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