Exchange of the year: Eurex

Risk Awards 2020: Success of futurisation project powers bourse to global top spot

Michael Peters

For the past two decades, Eurex has been the biggest European futures exchange. Now, with open interest of 169 million contracts as of the end of October, it can lay claim to the global crown, after outstripping the oldest and grandest bourse of all, Chicago’s CME Group.  

The Frankfurt-based venue has had a fair wind, with post-crisis reforms pushing over-the-counter derivatives products towards exchanges – and the self-inflicted wound of Brexit driving futures trades out of London. Plenty of other exchanges had the chance to capitalise on those opportunities too, though: Eurex has seized them through a combination strong product design, patiently building liquidity and above all listening to its customer base.

“Eurex talks to the market. They talk to their members, so we can talk to our clients and figure out what’s needed – then they create and deliver products,” says the head of futures execution at one large US bank.

That may sound obvious, but for a bourse that is trying to drag traders away from established OTC products, understanding the market is key – and not something every exchange gets right. Eurex’s approach is “an important differentiator from some other exchanges”, adds the futures head.

The proof of the pudding, in this case, is in those volume and open interest stats. As of the end of October, its Euro Stoxx 50 total return futures (TRFs) – products that mimic the economics of total return swaps (TRSs), a benchmark product for delta-one desks – boast a notional outstanding of €48 billion. That’s just over half the estimated €90 billion combined market for the OTC product and its listed rival.

For dividend futures on the same index, meanwhile, Eurex now holds more than 80% of all listed volume.

Currently, the futurised product set includes volatility futures, and dividend derivatives on benchmark equity index contracts, launched a decade ago amidst the crisis, which the bourse followed in 2016 with the first of its suite of TRF products. And more contracts are now being rolled out: dividend futures on the MSCI followed in October, along with basket TRFs.

Other contracts, such as property price index futures and corporate bonds are still gaining traction, but the market’s faith in the bourse’s patient approach has paid off handsomely before.

As Michael Peters, Eurex’s deputy chief executive puts it: “You standardise, then you create the critical mass. That is how we built the liquidity pools around the asset classes. We started with dividends 11 years ago, and [have now] replicated this with MSCI and total return futures.”

Trading in all TRFs has jumped by a fifth this year, following a strong 2018 in which the contracts benefited from bouts of volatility in February and at year-end. Structured products issuers are already keenly eyeing October’s cluster of new launches.

Major options market-makers expect the contracts to be a hit: “Once liquid, the MSCI products can become the most important set of products for worldwide investors to broaden their scope and diversify their assets,” says Martin Polak, chief operating officer of All Options, a Netherlands-based market-maker.

You standardise, then you create the critical mass. That is how we built the liquidity pools around the asset classes

Michael Peters, Eurex

Basket TRFs, meanwhile, offer significant advantages over their OTC cousins – in theory at least. Given the underlying baskets that TRFs track synthetically are constantly changing, it’s impossible for dealers to net longs with shorts, leading to ballooning balance sheets for delta one desks, and significant constraints on headroom. On exchange, not only can the products be netted between one another, they can also be offset against Eurex’s benchmark equity index futures and options.

The result should be significant savings in the short run, and a freeing up of capacity for clients afterwards – allowing dealers to print more business in the knowledge they have a benchmark product to lay off their risk.

This is also becoming an established pattern from Eurex, says the futures chief: “I think the MSCI dividend futures will be important. Euro Stoxx dividend futures, 10 years after they launched, are an essential tool for banks looking to offset structured product risks, and give end-investors a real opportunity to own dividends cheaply. We’re excited about them, along with all the other new products Eurex is launching, from ESG, to basket TRFs.”

Pulling in dealers looking to hedge is only one part of the liquidity puzzle in equity derivatives, however: for the products to thrive, Eurex is looking to diversify its liquidity pool and get the buy side to trade the benchmarks directly. Its outreach efforts are already bearing fruit: end-clients account for roughly a quarter of trading in MSCI futures and options, up from about 10% two years ago. Vast roadshows with US banks and their customers have yielded major new fund clients for the bourse, says Peters, such as First Quadrant, a West Coast manager with some $21 billion under management, mostly in equity strategies.

Buy-side take-up is being driven by several factors, he adds: order books are getting tighter, while growing open interest gives managers the confidence to execute larger trades. Many clients are already taking into account a margin hike on OTC products from the next phase of the non-cleared margin rules in September 2020, and are pre-emptively adopting listed products, he claims.

In riding the futurisation wave, Eurex has also benefitted from its existing strong equity futures franchise: clients trading newer total return futures against the bourse’s leading European index contracts can gain margin savings of 65% or more on average – a saving facilitated by its early adoption of a sophisticated, VAR-based portfolio margin methodology, an innovation rivals are only now taking up years later.

It is far healthier to have a diversified ecosystem of five to 10 liquidity providers rather than two or three

Michael Peters, Eurex

The confidence its margin model offers in allowing efficient offsets between products held in the same liquidation group is back-stopped by innate conservatism, however, says Peters. As banks become increasingly concerned about the increasing number of large variation margin breaches on futures exchanges – something Eurex has not been immune to this year – and the prospect of being left holding the bag if another clearing member defaults, the bourse has set the margin period of risk (MPOR) at three days for equity derivatives, and two days for fixed income. Other exchanges have MPOR as short as one day for similar contracts, notes Peters.

For Eurex, a longer MPOR is a badge of pride, and prudent given that liquidity in newly futurised products such as total returns and dividend indexes is not as deep as its core products. During stressful times, the market tends to retreat to wherever liquidity is deepest, which for some products might be the OTC market. Once liquidity dries up on exchange, it becomes that much more difficult to offload a portfolio.

“People have to look at how much time they would need in a distressed market to liquidate the respective positions. [But] we are not afraid of volatile markets,” says Peters: “We can demonstrate to clearing and trading members how robust the system is during those conditions.”

Like other exchanges, Eurex is cognisant of the need to protect its market-makers, and preserve a diversity of firms willing to make prices on exchange amid a race to the last nanosecond by firms using high-frequency trading. To ensure slower traders aren’t squeezed out by their better-equipped competitors, Eurex is implementing a speed bump that will pause resting orders for a few milliseconds before they can be executed on. The intent is to increase the number of liquidity providers and create a more diverse ecosystem.

The programme, which debuted in June, is being tested with German and French equity options. By the end of the year, Eurex will decide whether or not to extend it to other products.

“After three months, we see an incremental improvement, but it’s too early to come to a final decision,” says Peters. “It is far healthier to have a diversified ecosystem of five to 10 liquidity providers rather than two or three. We want to diversify, so speed is not the decisive factor.” 

As 2019 draws to a close, the bourse also looks to have won the race to build a liquid European benchmark in environmental and social governance: through October, trades on its Stoxx 600 ESG-X futures neared half a million lots; options on the benchmark followed later in the month.

The index, built by Eurex’s own provider Stoxx, includes stocks based on responsible investment policies, excluding companies deemed noncompliant with global compacts on controversial weapons and thermal coal. This gives the contracts a low tracking error and a similar risk/return profile to the benchmark Euro Stoxx 600.

“We believe, based on market feedback, it’s extremely important to have low tracking error,” says Peters.