As the world transitions from the ‘new normal’ to something resembling the ‘old normal,’ we sat down with Megan Morgan, the Global Head of Equity and Index Sales at Eurex, to get her views on the derivatives landscape that lies ahead of us.
Before we look forward, how do you look back at the period behind you?
Megan: Intense, insightful and with a good bit of pride. Pride in the resiliency of the financial system and us as a venue. Simply put, in a crisis, the market usually ‘just’ manages the risk of a market meltdown. Here we were able to manage a full-blown operational risk crisis. On the one hand, we had the usual market turmoil to deal with; the unprecedented load on our trading and clearing systems, the overnight doubling of collateral, the record volumes and a surge of margin calls combined. All this came right at the height of dividend season in the EU, with canceled AGMs, disturbing the dividend payouts and, as a consequence, index calculations and all equity derivatives.
On top of that, there was a heightened risk of market disruption around the March expiration, simply because there was a chance no one would be healthy enough to open the markets. And all of this happened while we were working from home for the first time. It was operational chaos that made industry veterans out of 2020 rookies. The silver lining is that these experiences will help us shape a better future.
Did the pandemic alter the strategy of the exchange?
Megan: We had to hit the pause button on some initiatives, but Covid didn’t change our strategy. As a matter of fact, we saw investment strategies supportive of the direction our listed portfolio was already taking. Sustainable funds and ESG indices are good examples. The move from niche to mainstream was already underway, but 2020 gave it a further boost. In our ESG contracts, we see that open interest jumped from €500M this time last year to €3.6B today.
The dividend uncertainty drove the market to use Total Return Futures as a beta replacement to our standard benchmark contracts. Until April last year, the primary growth in TRFs has primarily been driven by banks moving their swap and structured product exposure off their balance sheets. However, in June of last year, open interest surged to over 80B euros. That is about 56% of the total EURO STOXX® 50 futures market as investors turned to TRFs to mitigate dividend volatility.
And, we saw individual investors reaching into the derivatives markets. That is not just a lockdown fad but could be a systemic shift in the way investors invest. That demand is answered by listing smaller notional contracts and listing Micros on our major European benchmark contracts.
Before Covid, we were laser-focused on navigating Uncleared Margin Rules (UMR) to provide capital relief for those affected by regulation aiming to shift their OTC swap positions into listed markets. The banks were first to fall under this regulation, but recently, we also see a growing buy-side concern. The following two years are critical - Phase 5 of UMR comes into effect this September for firms with more than 50B euros of notional derivatives exposure, while Phase 6, covering firms with over 8B, follows September 2022. In the end, more than 1000 firms will be affected by UMR. Those firms will see their equity-related OTC transactions have an initial margin requirement of at least 15%, perhaps even 20%. For buy-side customers, this might not be a game-changer, but for their counterparties, it is.
How is the exchange going to tap into that game-changer?
Megan: We need to offer an alternative to reduce capital requirements. The first thing we are doing is to ensure our risk model is not only robust but scalable. Several years ago, we moved from a SPAN-like model to a portfolio-based model called PRISMA. Prisma’s risk calculation looks at a client’s individual trade in the context of their holistic portfolio. It provides an initial margin based on the portfolio’s risk rather than the individual product position itself, creating margin compression when trades reduce the total portfolio risk. We are looking at the 15% threshold on the equities side to ensure we offer substantial capital compression by moving positions from swap to Eurex.
However, just addressing margins is not enough. We also need to offer products that match the OTC market. In fixed income, UMR has manifested in CCPs clearing physical swaps. But on the equities side, it's more about futurization and creating alternatives to swaps. We started to build our UMR portfolio several years ago with our MSCI product suite. We listed over 164 futures and 24 options contracts on MSCI underlyings and have seen open interest grow to €130B. Most of this growth stems from dealers cleaning up their balance sheets. But, more and more buy-side firms anticipate UMR and move their positions to listed contracts as well.
Total Return Futures was another market where we were able to capture OTC conventions in a listed product. Five years after launching the EURO STOXX 50® TRF, nearly 70% of the OTC swap market has migrated to listed. Here too, the market was first dominated by dealers moving swaps off their balance sheet and a small group of specialized hedge funds. Now, we have a diversified base of buy-side customers trading repo as an asset class. Going a step further into mainstream investing, Amundi just launched a UCITS fund with a dedicated repo strategy based on TRFs. Earlier this year, we launched FTSE TRFs, to be able to expand the tradable repo universe. Once again, we see actual demand from dealers to move OTC positions to listed. We launched the FTSE product suite in March and have already seen almost 1B euros notional trade and $800M in open interest.
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