On Feb. 24, Eurex listed the world’s first total return futures (TRFs) tracking collateral indices, offering an alternative to bilateral swaps for buy-side investors who use synthetic portfolio replication.
Qontigo has licensed the iSTOXX® Europe Collateral Index and iSTOXX® Europe EUR Group 1 Collateral Large Index1 for the futures. The launch follows on the introduction in 2016 of the EURO STOXX 50® Index Total Return Futures (TESX), which represent the cost of the theoretical borrowing of cash to purchase the underlying index.
The iSTOXX Europe Collateral Indices reflect diversified baskets of securities that meet broadly accepted criteria for general collaterals, therefore representing generic index financing or collateral baskets. The index constituents are derived from the flagship STOXX® Europe 600 Index and satisfy criteria for liquidity and borrowing costs. In addition, only components that have no pending corporate event or dividend distribution are eligible for the indices.
“In effect what this product attempts to replicate is the synthetic equity financing business, replacing swaps with futures,” said Stuart Heath from Equity and Index Products at Eurex. He added that typical clients of swaps include asset managers, hedge funds, exchange-traded funds (ETF) issuers and structured-products desks.
At the moment, equity index total-return swaps are agreed upon on a very bespoke basis. A collateral index simplifies things for market participants by introducing a rules-based, standard reference of collateral that systematically updates monthly to include eligible securities. The listed, centrally cleared futures tracking the index offer analogous performance to total-return swaps with reduced counterparty risk, capital costs, collateral usage and bilateral margining charges.
Gaining exposure to the implied repo rate
“The total return futures provide cost-efficient access to the total returns of Europe’s benchmark blue-chip index whilst hedging the implied equity repo rate,” said Heath.
The implied repo rate is the profit earned from selling a futures contract and then buying the underlying or similar security in the cash market using borrowed money.
Selecting the collateral basket
The iSTOXX Europe Collateral Indices are separated by market capitalization into large- and mid-cap indices. Index components must comply with minimum thresholds of average daily trading volume and borrowing fee and capacity. Inclusion of the remaining stocks into the respective index will be determined by the ISIN country code and exchanges that are included in the methodology.2 Securities that have either a corporate event or an ex-dividend date falling between review implementation dates are deemed ineligible.
The indices are divided into groups depending upon the currency of the exchange, and on whether its country applies a financial transaction tax, stamp duty or turnover tax.
For more information on how index total return futures work, please visit Eurex’s description page.
TRFs for ETF providers
The new TRFs are also aimed at clients who require a total return product on the collateral basket underlying an ETF. With collateral index TRFs, ETF provider rules – stipulating, for example, the inclusion of only certain high-quality assets – set the framework for inclusion in the collateral basket.
“After we introduced the EURO STOXX 50 Index total return futures, we were approached regarding products to assist in the diversification of swap counterparties for ETFs that use synthetic portfolio replication,” said Heath. “We are now responding to this market demand. While an index TRF can only provide a partial solution for many ETFs, the collateral index total return futures offer a full solution based on the collateral or substitute basket underlying an ETF.”
1 Both indices are calculated on a net return basis.
2 The iSTOXX Europe Collateral Index includes all companies that meet the selection criteria and are traded in the following exchange codes: AS, BR, CO, DE, HE, LS, MC, MI, OL, PA, ST, VI, WA, excluding those with ISIN country code of FR, IT and CH. The iSTOXX Europe EUR Group 1 Collateral Large Index includes all companies that meet the selection criteria, have a free-float market capitalization that is equal or larger than the median of all securities in the original universe, and that have either an ISIN country code of AT, BE, DE, FI, LU and NL and are traded in a EUR-denominated exchange; or with ISIN country code of IE, GG, IM, JE and GB and traded in the following EUR-denominated exchanges: AS, BR, DE, HE, PA, VI.