Exchange of the year: Eurex

Risk Awards 2017: Futurisation paying off as bilateral margin rules bite

Successful product launches are few and far between for futures exchanges. The rare chemistry of demand, supply and liquidity cannot be conjured up at will.

But over the past few years, Deutsche Börse's Eurex can point to the launch of a clutch of contracts that have rapidly become benchmarks in their own right – quietly revolutionising the way users transfer risk in key markets such as European government debt and equity derivatives in the process.

The latest – December's launch of total return futures (TRFs) on the Euro Stoxx 50 – was spurred by the looming implementation of the non-cleared margin regime for over-the-counter derivatives. The contracts allow users to replicate the performance of index swaps on the equity benchmark, with the promise of lower on-exchange margins and the added lure of netting and cross-margining.

In a little over two full weeks of trading, the contracts racked up 20,130 lots, worth a notional €650 million. To put that in context, when the bourse launched dividend index futures eight years earlier, the first two months of trading saw a total of 3,000 contracts traded. Average daily volume for the contracts now exceeds 20,000.

"The move to exchange variation margin and initial margin in the bilateral world and the fact that this exchange of margins will sit on the balance sheet and attract additional capital charges has been a key driver for TRFs," says Mehtap Dinc, Frankfurt-based board member and head of derivatives product development at Eurex in Frankfurt.

TRFs produce a payoff analogous to a total return swap (TRS) on the Euro Stoxx 50. Their structure allows for more precise and longer-dated hedging of forward exposure, argues Dinc.

The growth rates we have seen in dividend futures could not have happened if both the buy side and sell side had not seen the benefits of standardisation and cross-margining
Michael Peters, Eurex

"Banks will see capital requirements increase further in 2017. We believe it makes perfect sense that we offer standardised alternatives for some of the products currently trading OTC. With TRFs, we have standardised the contract and combined it with a proven risk methodology for mitigation of counterparty risk," says Michael Peters, deputy chief executive at Eurex in Frankfurt.

Eurex is betting the drive towards greater standardisation among equity derivatives market users – with the added push of capital incentives – will see TRFs replicate the success it has achieved with its dividend index futures, now a stable hedge for structured equity dealers. The product achieved a monthly volume record of 1.4 million contracts in February 2016 and open interest of 5 million contracts in June.

"Before we launched dividend derivatives on our platform, they were entirely OTC traded, so the market was relatively limited due to the bilateral agreements that had to be exchanged," says Peters. "In addition, you have the respective cross-margining capabilities firms can utilise. The growth rates we have seen in dividend futures could not have happened if both the buy side and sell side had not seen the benefits of standardisation and cross-margining."

A strong selling point for Eurex's equity index and dividend futures suite has been their utility for managing risk in long-dated forward exposure in structured products books, which have traditionally been hedged using a combination of listed products such as Stoxx 50 futures and options, and OTC products such as dividend swaps and TRSs.

"As an added benefit, the dividend futures have increased the number of market participants and brought more liquidity to the market, to a point where trading is balanced evenly between the order book and block trades," says Dinc. "This has resulted in a reduction of structural imbalances, where large broker-dealers were traditionally sellers of dividend risk."

Eurex has also shown a willingness to take corrective steps when faced with criticism. For example, when it launched US dollar-denominated Euro Stoxx 50 quanto futures in March last year, it touted the products as a hedge for dealers' structured product exposures, or short-dated cross-gamma risks in other products.

However, some banks criticised the product as too short-dated to be an effective hedge for structured products that reference the index. The contracts are currently listed with quarterly expiries out to a maximum of nine months – but the vast majority of risks emanating from retail structured products such as autocallables have an average maturity of between two and three years.

Eurex says it is evaluating whether to extend the duration of the product beyond nine months. "We are currently analysing the benefits of a maturity extension of the Euro Stoxx 50 futures, and are in close contact with market participants on this topic," says Dinc.