The expansion of Eurex’s credit futures offering into dollar and multicurrency products promises broader and deeper opportunities for investors.
A keen buy-side appetite for credit index futures in the US and European markets is accelerating demand for product development. Lee Bartholomew, global head of derivatives product R&D for FX and fixed income at Eurex, discusses this rapid change and the expectations for further growth.
What are the current drivers for investment managers to adopt credit index futures?
There are three themes that we observe in our conversations, which are cost, access and operational challenges. Active managers have increasingly come under pressure by the growth of passive investment vehicles. They are looking at alternative liquidity pools to improve the cost of execution, for products that are fungible, liquid and transparent. Electronification and indexed trading through portfolio trades and exchange traded funds (ETFs) have improved the price discovery and liquidity in the fragmented landscape of European credit markets. However, over the counter (OTC) credit derivatives markets remain opaque, operationally challenging and not universally accessible, even to institutional investors. This is exactly where we as an exchange can provide value, as we have done in equity index and government bond markets. Our central limit orderbook (CLOB) is transparent and we have a diverse set of liquidity providers that provide prices on-screen and for block trades. Finally, we have seen that there is demand for a global suite of products, which we have added to with our USD Emerging Market Sovereign index futures and GBP Investment Grade index futures early this year. In particular, the emerging market product has seen great interest as a tool to manage emerging markets beta in both sovereigns and corporates. A global product suite across geographies and currencies is efficient from both operational and capital perspective and this is exactly why we have decided to build a global cross-currency portfolio of products.
How would you compare US to European markets?
Adoption in Europe is typically slower than in the US. This is driven by several factors, most notably how differently market participants evaluate new opportunities that is also an expression of general culture. Europeans tend to focus on interoperability and integration with existing systems more and will spend considerable time on ensuring that everything integrates perfectly in up-and downstream systems before using a new product. US market participants tend to be more pragmatic and dynamic and there is definitely a “make it happen” culture.
We expect that adoption of credit futures in the US will drive mass adoption across the whole product segment and across global geographies. US dollar is the biggest currency and more than 70% of global debt is USD-denominated. Even in Europe, many asset managers are looking to express views on US credit markets using futures, and we expect operational efficiencies around analytics to realise as a result of a growing user base. Key buy-side risk and portfolio management systems such as Aladdin and PORT have embedded the products already, and we expect the ecosystem around these futures to grow significantly in the near future.
What depth and breadth of market are you seeing in credit products?
To build out the ecosystem it is necessary to have genuine client demand, and this is a product driven by the genuine end user; real money, multi strategy, asset managers and pension funds, who have used our products to allocate additional beta or hedge risks on a tactical basis. They tend to be less opportunistic than hedge funds and the products provide real value to their operations. The kinds of desks involved in that market is reflective of our product strategy. We have launched broadly diversified indices that have the highest correlation to most portfolios, which appeal to multi-asset investors that wish to steer beta. As we launch across more underlyings and more currencies, you will see asset-specific teams looking at the products and later, sector-specific teams within those. That creates a cross-selling effect and organic growth within that segment. As you build the volume, and open interest, you can bring in opportunistic macro players to use the products as part of their toolkit and put on more tactical positions. Finally, our ambition is to build out the CTA group.
As you know, liquidity is a chicken and egg problem, but we have been fortunate enough to have great support from several key players like Goldman Sachs, Jane Street and Susquehanna among a growing number of competitors. The Liquidity providers are able to source liquidity from both cash and ETF markets and other correlated markets and we have seen increased competition with more and more firms joining our journey.
How is activity in these instruments affected by increased electronification of the cash market?
We have a clear vision, which is that global credit markets will be as liquid and easy to trade as equity markets. While credit index futures are the engine behind that vision, electronification and indexation are the fuel that makes the wheels of liquidity turn. Indexed trading, such as bonds portfolio trades and fixed income ETFs, is essential for price discovery and as liquidity pools for our market makers. However, electronification and the tackling of fragmentation through technology has made indexed trading possible in the first place. The credit index futures are just the next logical step in the evolution of credit trading.
What future developments do you have planned?
We are already multi-currency with our emerging market and Sterling offer, but we want to take the suite to the next level. The US is our next target market. I see investment grade and high yield index futures coming in Q3, and then some more bespoke launches thereafter. That is what is most exciting about this space; the sheer amount of potential that lies ahead, with opportunity in various currencies, geographies, sectors and rating classes. 
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