Margin Rules to Boost Futures Volumes

Shanny Basar

Eurex, Deutsche Börse’s derivatives exchange, said there has been significant interest in the total return futures launched last month as new margin regulations are likely to shift trading from the over-the-counter market onto exchanges.

The new variation margin rules for uncleared over-the-counter derivatives will come into effect on 1 March 2017 and will immediately apply to a wide variety of counterparties including dealers, buyside firms, pension funds and corporates. The initial margin rules began to be phased in September last year for the largest swap dealers in the United States, Japan and Canada, and will be implemented in Europe and Asia this year.

Eurex launched total return futures on the Euro Stoxx 50 index last month before the margin rules come into force in order to offer similar returns to equity index total return swaps, but with more capital efficiency than uncleared OTC instruments. For example, there could potentially be substantial margin offsets if the total return futures are being used to hedge Eurostoxx futures.

Stuart Heath, executive director at Eurex Exchange, told Markets Media: “Since 2 December, circa 14,000 contracts have been traded. They are likely to be a slow burner although significant interest has been shown.”

Heath added that it is possible that Eurex total return futures could be extended to other indices. “We are taking baby steps on the existing index before expanding,” he said.

The total return futures positions can be netted with other contracts of same expiry at Eurex allowing more efficient use of capital. Initial margin offsets will be calculated within Prisma, Eurex’s risk system, alongside all other equity futures and options, including dividend derivatives. Trades executed on Deutsche Börse have to be cleared on that exchange, so Eurex Clearing acts as a central counterparty, mitigating counterparty risks.

Thomas Book, chief executive of Eurex and head of derivatives markets trading at Deutsche Börse Group, said in a statement: “The introduction of margin requirements for bilateral instruments will make exchange-traded derivatives more attractive.”

The Bank for International Settlements said in its latest quarterly review that the new margin requirements for uncleared derivatives could raise costs and encourage a shift of more interest rate trading onto exchanges and into central clearing.

The BIS said: “Regulators continue to expand clearing requirements, and many are also starting to require higher capital and margin for non-centrally cleared derivatives. This strengthens the incentive to move trades to CCPs. In the United States and other key markets, margining requirements began to be phased in starting in September 2016, so their impact on clearing will only become clear in future data.”

Eurex said that a series of events last year provoked high volatility in underlying markets. As a result 1.73 billion contracts were traded in 2016, a 3% increase from the previous year with the highest turnover in Euro Stoxx 50 index futures.

Kevin McPartland, principal, market structure and technology at consultancy Greenwich Associates, identified increasing futures volumes in the report, Top Market Structure Trends to Watch in 2017, due to both rising interest rates and regulatory changes.

“Putting aside the potential softening of some US regulations, the cost of capital will continue to hit banks and, as a result, their customers,” added McPartland. “Investors will therefore be forced to look harder at more cost-effective cleared products.”

Heath said: “There has been heavy interest from the buyside in listed products. This will be driven by pricing from the banks, who may find it cheaper to offer a listed contract rather than an OTC product.”

Heath said banks are feeling the most impact of the new regulations and JP Morgan, BNP Paribas and Unicredit are market makers for the Eurex total return futures.

McPartland said market participants will be looking for cleared products beyond interest rates and energy into credit and foreign exchange which is a good sign for futures markets.

Heath added: “The total return futures have been designed so they can be replicated in other asset classes but they are not suitable for all OTC products, which are bespoke. I describe them as a bus which gets you close to the right direction, while you might need a taxi if you want to reach the front door.”

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