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Alternative Market Briefing

Total Return Futures are gaining recognition on both sides

Tuesday, September 28, 2021

Nicolas von Kageneck
B. G., Opalesque Geneva:

Regulatory changes have driven OTC business to listed solutions since the 2008 financial crisis. The Eurex Total Return Future (TRF) on the EURO STOXX 50® index is a prime example of this so-called futurization process, making TRFs a widely accepted alternative to OTC swaps for repo trading.

Eurex introduced TRF contracts in December 2016 to provide market participants with a new instrument for managing repo risks on equity markets. They are the listed alternative to Total Return Swaps* (TRS). Eurex TRFs are standardized, centrally cleared futures contracts that replicate the net pay-out profile of traditional, bilaterally negotiated equity or equity index-based swaps. Buyers of TRFs receive the performance of the EURO STOXX 50® price return index, plus 100% of the realized dividends. In return, they pay the euro short-term rate €STR plus a spread known as the equity financing rate. The equity financing rate provides investors with unique investment opportunities, both from a carry perspective and in terms of cost optimization.

"It all started around 2015 when the dealer banks approached us, expressing interest in replacing swaps with futures," explains Nicolas von Kageneck, senior equity & index sales at Eurex, to Opalesque. Indeed, after the 2008 crisis, many banks looked to mitigate capital, collateral and balance sheet pressure stemming from new regulations. One of those critical regulations coming into force in 2016 was the Uncleared Margin Rules (UMR)** for non-centrally cleared OTC derivatives. The banks were interested to see a futures contract implemented.

"Futures are centrally cleared and listed; when you trade against a counterpart, you are facing the clearinghouse instead of the risk of the counterparty. It is more interesting now to trade futures in a post-crisis era than to continue to do bilateral swaps. There is still a need for swaps handling bespoke, complex products. Still, buy-side clients, namely hedge funds, long-only managers, and pension funds, are now more interested in trading futures at Eurex or other venues if a good alternative is available."

Buy- and sell-side clients are also becoming more aware of the benefits of margin optimization, allowing for increased leverage and profits. Moving from OTC to listed derivatives trading delivers significant margin savings as TRFs enable high netting effects with other equity and equity index exchange-traded derivatives.

A steady rise in demand

TRF demand has risen steadily since the first TRF on the EURO STOXX 50® index was launched. While the demand initially came from the sell side, there has been significant uptake on the buy-side and from firms that recognize the central clearing and margin offset benefits. Regulation was a catalyst for banks to promote replacing swaps with futures. Furthermore, as the last phases of buy-side firms also come into scope for UMR, buy-side firms are actively seeking cleared alternatives to swaps that reduce their margin obligations.

"There has been a marked continued growth in terms of traded volume since 2016, especially last year with the high uncertainty around dividend payments," says von Kageneck. "A lot of companies were recommended not to pay any dividends. It was more interesting for market players to use TRFs. Due to the total return nature of these products, there is less price sensitivity to dividends compared to price return futures."

TRFs are still relatively new as a product type, and despite widespread acceptance, large traditional asset managers might hold back until more such products are available. So there is still much room for growth.

"The TRF is not only an interesting product to manage dividend risk; it is also a way to trade equity repo as a separate asset class," adds von Kageneck. "Banks can pitch existing clients with new trading ideas and they can attract new clients that have not traded TRS in the past due to regulatory considerations, balance sheet limitations, or credit line restrictions."

Institutional investors, such as asset managers and pension funds, as well as hedge funds, are focused on the trading of calendar spreads to capture the expected alpha from the downwards-sloping repo term structure.

Next webinar:

Total return futures: The Great Migration: How hedge funds and active strategies profit from new instruments on regulated exchanges

When: Thursday, October 7th at 10:30 am ET
Free registration:

A MASTER CLASS for hedge funds and active investors with Stuart Heath, Nicolas von Kageneck, Natasha Sibley, and Antoine Deix:

• Why Repo is emerging as a new asset class
• How Total Return Futures deliver margin efficiency & trading opportunities for buy and sell-side. The three benefits of Total Return Futures over Total Return Swaps.
• When dividends are uncertain: Time to switch to Total Return Futures
• How institutional investors such as asset managers, pension funds and insurance companies can benefit from the dislocation in the repo term structure and from locking in financing spreads and repo levels on longer maturities
• How margin optimization allows for increased leverage and profits
• How to use Equity Total Return Futures and Basket Total Return Futures in a smart way


* A total return swap is a swap agreement in which one party makes payments based on a set rate while the other party makes payments based on the return of an underlying asset, which includes both the income it generates and any capital gains. The underlying asset is usually an equity index, a basket of loans, or bonds. It is owned by the party receiving the set rate payment.

** Post the financial crisis of 2007-2008, the G20 instigated a regulatory reform compiling of a list of international standards to cover OTC derivatives markets and other market participants. In 2013, the Basel Committee for Banking Supervision (BCBS), along with the International Organisation of Securities Commissions (IOSCO), produced a framework for margin requirements for non-centrally cleared derivatives. From this, global regulators implemented the BCBS-IOSCO framework into a set of rules titled 'Uncleared Margin Rules' or UMR, which would be phased in over a set period and require the exchange of initial margin (IM). As per the European Market Infrastructure Regulation (EMIR), implementation of variation margin (VM) requirements occurred in 2017, whereas IM requirements are currently being phased in, up until 1 September 2021.

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