Futurization, or the transfer of over-the-counter trading to listed and centrally-cleared derivatives, will grow with more innovative and tailored indices coming to the market, according to a panel of experts at the recent Eurex Derivatives Forum in Frankfurt.
Regulation aimed at limiting investment risk was a key driver in the launch of exchange-traded futures and options in the past two decades. However, the trend has most recently been underpinned by asset owners’ differentiating strategies, and the tailoring of indices to target them, the panel said.
“It’s a demand-supply question,” Serkan Batir, Global Head for Product Development and Benchmarks at STOXX, said during the discussion. The buy-side is “seeking new returns and risk management” tools. “You have the benchmarks or plain-vanilla indices which have been in the space for quite a long time but now we are seeing customization in that exposure. And those are the indices that will end up having futurization,” as market participants “seek new returns, and go for more precision and niche exposures.”
The 2008 global financial crisis prompted regulators around the world to limit the risk that asset owners and intermediaries take when entering positions, boosting volumes in the listed derivatives market. The segment of dividends derivatives, in particular, was highlighted during the panel as an example where liquidity has moved on-exchange, bringing plenty of benefits to traders and investors.
Over 5 million contracts in EURO STOXX 50® Index Dividend futures traded on Eurex in 2023, for a notional volume of EUR 72 billion. The EURO STOXX 50 is at the center of an ecosystem that includes options (including daily expirations), futures and total return futures on the index, its dividends and its volatility. About 246 million EURO STOXX 50 index futures and 253 million EURO STOXX 50 index options traded in 2023 on Eurex. The Eurozone blue-chip benchmark is also a popular underlying for ETFs, with USD 33.3 billion currently invested in the funds[1].
Hedging risk
Speaking at the Eurex event, Wilrik Sinia, Director at Mint Tower Capital Management in Amsterdam, described how the advent of listed dividend futures dramatically changed trading, from cumbersome phone negotiations with heightened counterparty risk “to a very automated process.”
In the past, the amount of risk taken by traders would be out of sync with the size of the trade, Wilrik said. These days, however, products such as EURO STOXX 50 dividend futures allow participants to hedge every single risk source in the market, including market, dividend, earnings and repo risk, he said.
This targeted exposure is what makes dividend futures an “incredible” alternative to company shares, and dividends an asset class in themselves, Gabriel Messika, Head of Index Forward Trading Europe at J.P. Morgan, told the audience.
“When you have a view on the earnings of a company, it’s a lot easier and clearer to express that view with dividend futures and options other than the share price itself, which moves with a lot of other reasons than earnings,” Gabriel said.
All speakers agreed that the more liquidity flows into on-exchange trading, the more risk market participants can take.
The future of futurization
Lorena Dishnica, Product Manager for equity and index at Eurex, mentioned the recently launched mid-curve options on EURO STOXX 50 index dividend futures as an example of innovation. She said the exchange is looking to add so-called swaptions on single stocks, and mentioned the STOXX® Europe 600 index as an index whose trading ecosystem could be expanded as it’s happened with the blue-chip EURO STOXX 50. In the future, derivatives could also track companies’ earnings-per-share, she added.
Wilrik at Mint Tower and Gabriel at J.P. Morgan said they expect higher volumes and more product innovation in the total return futures market.
‘Outsourced product developer’
As pension funds and insurers review their liabilities, Serkan at STOXX said the role of index providers has also evolved with the need to customize strategies and to bring them onto a regulated market.
“Twenty years ago we were simply an index provider,” he said. “Now we are more of what I call an outsourced product developer.” If a client doesn’t have the resources and know-how in-house, an index provider can supply the necessary expertise to build solutions and investable products, Serkan explained.
Today, indices are vital to the trading landscape, and they must be independent, reactive and “bullet-proof” in all market circumstances, Serkan added.
“At the end of the day, the sell-side and the buy-side are using the index to hedge their dividend, interest rate, collateral and volatility risk, and all that is embedded into one index,” he said. “That index needs to work no matter what happens,” he said, in reference to corporate actions within constituents, such as dividend cancellations.
[1] Source: Morningstar, data as of February 2024.
