Eurex takes a bite of the total return swap pie

Darren Sinden

The trades made on Eurex were for equity total return futures which aim to replicate the returns of equity or equity index total return swaps

A little bit of history was made this week as Eurex and its partners BNP Paribas and Goldman Sachs traded a new kind of futures contract for the very first time, part of a move towards what is known as the “futurization” of one of the worlds largest markets by notional value, swaps.

The International Swaps and Derivatives Association (ISDA) estimated that the total outstanding notional value of these OTC contracts to be $606 trillion as of the end of H1 2020, the vast majority of that was in interest rates and FX contracts.

The trades made on Eurex were for equity total return futures which aim to replicate the returns of equity or equity index total return swaps, which would traditionally have been negotiated between counterparties and traded over the counter, rather than on an exchange.

Eurex’s new BTRF basket trading function allows market participants to create total return swaps over equity baskets and then to trade that contract as an exchange-traded future.

In an equity total return contract, the counterparties create a bespoke basket or index of stocks, which may contain both long and or short positions. The counterparties to the trade agree to pay or receive the total return from the basket based on its performance, and whether they are long or short of the basket or index.

The financing costs of funding the basket are pre-agreed, for example, at an interest rate benchmark plus or minus a number of basis points.

Such contracts have allowed banks and sophisticated investors to gain economic exposure to equities at cheaper rates than would be available by holding the underlying constituents of the baskets.

Total return swaps have also been used by margin trading houses and market makers to hedge or collateralise their overall positions and by hedge funds to deploy trading strategies.

One other advantage of trading such contracts on-exchange is that they then become centrally cleared, with the counterparties to a trade posting margin to the neutral clearinghouse, rather than between themselves, as is the case when they are traded on an OTC basis. That helps to simply settlement, reduce costs and facilitate cross margining with other positions held at the clearinghouse.

The trade between Goldman and BNP was part of a Eurex pilot program and the details were not disclosed. However, this does mark an important milestone in process of making futures trading and clearing, attractive to swaps dealers.

Antoine Danneel, Head of Equity Finance Europe Prime Services & Financing at BNP Paribas said that “The ability to trade listed derivatives as a basket and the introduction of the concept of substitution is a significant step towards the listing of equity financing products and broadening market access. We are confident it will attract many types of investors and market participants. It encompasses the benefits of futures while keeping the flexibility of baskets.”

Whilst Lorenzo Pasquale Longo, Head of EMEA Forwards Trading at Goldman Sachs commented that “The BTRF product represents an important development in the Equity Financing market by providing a listed product referencing standardized basket terms, as an alternative to a predominantly OTC traded product. In turn, it can offer market participants the benefit of optimizing initial margin. We recognize the benefit that the BTRF product can generate for the market and are excited to contribute further to its development.”

Total return futures themselves are not new to Eurex the exchange launched TRFs on the EURO STOXX 50 index back in 2016 and on 255 individual stocks in 2019.

Eurex highlighted the fact that current open interest in Euro STOXX 50 total return futures was more than 2 million contracts with a notional value of more than €70 billion which represents just a fraction of the total equity finance market in Europe and it hopes that the new BTRF functionality will allow it to capture a much bigger piece of that pie.

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