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Monthly Archives: November 2016
Hedge funds and other market participants are paying close attention to the changes going on in the Treasury markets and the role of futures. HFC’s Stefan Nilsson recently had a chat about this and other trends in the FX and rates space with CME Group’s Ravi Pandit.
Singapore-based Ravi Pandit serves as Executive Director, Foreign Exchange and Interest Rate Products, Asia Pacific, for CME Group. He is responsible for expanding CME Group’s existing FX and interest rate business and developing new opportunities across the region. Pandit joined CME Group in 2015 and has 25 years of experience in the financial markets. Prior to joining CME Group, Pandit was a consultant to Singapore Exchange, where he provided strategic advice and project management for its launch of listed FX futures. Before that, Pandit worked for 12 years in Dresdner Bank and subsequently Commerzbank post-merger, where he headed up the local markets trading team and helped build up its Asian presence in interest rate and FX derivatives trading. Pandit also worked in various trading roles at Barclays Bank in Hong Kong, Singapore and Tokyo, and in operations and technology at Citibank in Hong Kong and Mumbai. Pandit holds a master’s degree in Chemical Engineering from Syracuse University and an MBA in Finance from the University of California, Berkeley.
What is your outlook for the treasury market? Will we see futures having a significant impact on the cash markets?
Treasury cash market liquidity has been impacted by banking regulations such as the leverage ratio and consequent lack of growth in bank balance sheet. This can be evidenced by negative swap spreads which have persisted since September 2015, shrinkage of the repo market, and increasing price impact of trades. In the face of these challenges, Treasury futures offer market participants a capital efficient, off-balance sheet instrument for exposure to Treasuries. We have seen reports by market commentators which talk about how the liquidity in Treasury futures has become comparable to, if not superior to, liquidity in the cash Treasury securities markets, and that futures are especially resilient during non-US trading hours. Treasury futures daily volumes are now 77.8% of the cash market (on a 52-week moving average), up from 56% in 2012. This shift is expected to continue as participants realise the value proposition provided by Treasury futures from a round-the clock liquidity and capital efficiency perspective.
How can treasury notes be used as effective hedging tools?
Treasury futures provide an effective risk management tool that is liquid 24 hours a day. These instruments are listed with a variety of maturities, based on current market conditions. Their effective durations are approximately 2, 5, 7, 10, 20 and 25 years. Additionally, participants needing exposure at another maturity point can use a combination of these instruments to create a hedge. In a basic hedging strategy, Treasury futures can be bought – to hedge for a short cash bond or paid IRS position – or sold – to hedge for a long cash bond or received IRS position. The number of futures to be used for hedging is generally determined by matching the BPV (basis point value) of the Treasury futures contract to be used, with that of the underlying exposure being hedged. Besides directional hedging of a single exposure or a portfolio, Treasury futures can also be used to trade spreads versus other assets, such as corporate bonds or interest rate swaps, as well as targeting curve exposure for relative value positions, such as 5-year versus 10-year spread. In response to strong client demand, in January 2016 CME Group introduced the Ultra 10-Year Future, providing close proxy for cash 10-year Treasury note exposures, with an innovative application of the classic deliverable basket structure of Treasury Futures. This capital efficient instrument is highly complementary to existing benchmarks, enabling new spread and curve trading opportunities. In the 10 months since launch, we have seen wide market adoption with over 300 clients participating globally and open interest growing to 250,000 contracts.
What has the impact of uncleared margin rules been on bilateral trades?
Uncleared margin rules, imposed by the BCBS, have been implemented starting from September 2016 in a phased manner and are expected to cover most counterparties in all major jurisdictions by September 2020. The main thrust of the rules is the imposition of initial margin and variation margin for all non-centrally cleared derivatives. The imposition of the rules is expected to increase the cost of trading bilaterally on an uncleared basis due to the cost of posting initial margin with all bilateral counterparties – netting benefits are not achievable for bilateral trades – as well as the operational complexities of calculating and settling these margins. In the rates and FX products space, the products most likely to be affected include non-deliverable forwards (NDFs), FX options, cross currency swaps, swaptions, other OTC options and inflation swaps. Where the cost of trading bilaterally becomes prohibitive, we could see these market shrink or migrate to a centrally cleared or listed alternatives.
What other major trends are you seeing or expecting in the rates and FX space?
There is a great deal of interest from market participants in looking for capital efficient listed or centrally cleared solutions for replicating bilateral OTC trading. This has resulted in a significant increase in the clearing of non-mandated products. CME has seen evidence of this in the tremendous uptake of interest rate swaps denominated in Mexican peso and Brazilian real, and is beginning to see increased interest in clearing U.S. dollar swaptions and clearing FX non-deliverable forwards clearing. CME is also working on solutions to help reduce the margin impact for other products affected by regulations, including OTC FX options, additional interest rate swap currencies and a solution for clearing the repo market. We also expect a parallel increase in trading of listed FX and rates options, given the growing number of participants using these standardised instruments for managing risk. Related to the trends in OTC products is the evolution of the execution models as a result of growing client demand for more centralised and efficient forms of price discovery. History shows that when products begin trading electronically, the increased transparency and access expands the overall client base, particularly from international markets, and therefore the liquidity and trading volumes improve as a result. We have seen this trend manifest itself in listed interest rate options, where new firms have started participating in the electronic markets and, as a result, the percentage of options traded electronically has increased. In October 2016, this metric reached over 73% for Treasury options and 25% for Eurodollar options, a substantial uptick from a year ago.
According to Eurekahedge, net flows for Asia ex-Japan mandated hedge funds went in the red for the year following steep redemptions worth US$2.1 billion in October, the highest monthly redemption on record since July 2012. Overall asset growth for Asian mandates is in the red for the year following disappointing returns from Japan (down 0.92%) and Greater China (down 2.15%).
Scott Treloar has recently established Noviscient, a technology-led, research and proprietary trading firm based in Singapore. Noviscient applies statistical and machine learning technologies to investment management challenges. Treloar was most recently a portfolio manager and chief risk officer at Vulpes Investment Management. Earlier in his career he was at Deutsche Bank, Novalis Capital, Committed Capital and Macquarie Bank.
Scott Anderson has been hired as a portfolio manager by Lazard Asset Management, based in Tokyo and supporting the firm’s Japanese equity investment funds. Most recently, Anderson was the head of Japanese equity research for Russell Investments. He was responsible for leading Russell’s research on the Japanese equity market to support both the firm’s asset management and consulting businesses. Prior to joining Russell, Scott was a senior manager with Nomura Asset Management.