Total Return Futures (TRFs) have become widely accepted alternatives to OTC swaps for implied repo trading. With the launch of a set of new index derivative products based on the FTSE Russell 100 index, including FTSE 100 TRFs, and growing buy side demand for listed alternatives to swaps, Eurex sees potential for further futurisation of traditional OTC trading strategies, according to Stuart Heath, Director, Equity and Index Product Design, Eurex.
Eurex recently launched a package of products in partnership with the FTSE Russell 100, including FTSE 100 Total Return Futures (TRFs), dividend point futures and index futures and options, following demand from their joint customer base. Eurex already lists and clears TRFs and other derivatives on two key European blue-chip benchmarks – Euro STOXX 50 and SMI. It made sense to add a UK blue chip index as an underlying. The set of index derivative products for the FTSE 100 mirrors what is available for the existing index product sets.
Demand for TRFs has risen steadily since the first TRFs on Euro STOXX 50 Futures were launched in 2016. Dealers drove initial demand for TRFs, which is an exchange-listed solution for implicit repo trading and serves as an alternative to OTC total return swaps (TRS).
The previous way of hedging repo exposure with TRS was heavily impacted by capital constraints and there was a shift to the synthetic product using options. It made sense for Eurex to offer index options on the FTSE so that product could be unwound. It then also made sense to round off the product suite by bringing in dividend or index dividend futures as well. Eurex has introduced the whole product suite to facilitate the demand driven on the FTSE TRF.
TRF demand extends from sell side to buy side
While demand for TRFs initially came mostly from the sell side, there has been significant uptake on the buy side as well as firms who recognise the central clearing and margin offset benefits. Regulation has served as a catalyst for banks to promote replacing swaps with futures, and as the last phases of buy-side firms also come into scope for the Uncleared Margin Rules (UMR), buy-side firms are actively seeking cleared alternatives to swaps that reduce their margin obligations.
TRFs are still relatively new as a product type, and despite widespread acceptance, there is still much room for growth. Until recently, there was only one European TRF product on the market, and large traditional asset managers might have held back until more such products were available. Now that Eurex offers TRFs on three separate indices, and new listed products have been launched elsewhere on the US S&P index and on Asian benchmark indices, Eurex anticipates that more traditional asset managers will be drawn to TRFs, seeing them as globally valid instruments.
The opportunities for the buy side are becoming clearer. The sell side hedging strategies and alternative risk premium strategies are well known by hedge funds and already adopted. There is now a potential breakout of demand by the broader buy side for the straightforward beta replacement of swaps that are currently traded OTC. TRFs are a dividend neutral product and many firms turned to TRFs in 2020 when the impact of dividend expectations was hit hard by the pandemic. With banks promoting their capabilities in pricing, processing and position management of TRFs, it will make the switch to TRFs easier for buy-side firms when they do get covered by UMR, and they may find they get better prices as well.
Futurisation trend continues
TRFs are just the start. There are many other opportunities for moving what is currently traded OTC into the cleared and listed environment. Futurisation has been an ongoing trend for many years, driven mainly by global regulators looking to minimise the risk of interconnected markets and push products into central clearing. TRFs are the sort of product that enables this.
In terms of equity and equity index derivatives, the market has always been more balanced in terms of OTC versus exchange trading. Far from being disruptive, listing TRFs on equity indices has provided market participants with additional transparency and distribution of the product. Client adoption is key. Most of the big futures dealers have onboarded the product for themselves initially. Incorporating the TRF product into this product set that they can offer the buy side is a relatively small step.
Eurex sees other opportunities for the futurisation of products, where swaps are currently used for no other reason that they are already embedded in firms’ processes. Exchange-traded products will continue to replace OTC products – up to a certain point. Some OTC products are custom designed for particular uses and clients and will remain so. But the futurisation trend will continue so that more and more swap-like products in particular are brought into the listed and cleared space.