RiskNews

TFS offers property derivatives

Tradition Financial Services (TFS) has become the latest inter-dealer broker to enter the property derivatives market. TFS, a subsidiary of Switzerland-based Compagnie Financière Tradition, joins rivals GFI, Icap and Tullett Prebon, all of which have launched property derivatives desks over the past few months.

Participants have high hopes that the property derivatives market will become a high-volume flow business, as banks such as Barclays Capital, Deutsche Bank and Credit Suisse First Boston all gear up to offer these swaps to end-users. Consultants Deloitte & Touche estimates the market will reach £20 billion in turnover by 2008.

In July, Tullett Prebon opened its three-strong desk, which is expected to expand to five people by the end of the year. "We have been researching the market for some time now, and believe there is a growing demand for new and viable ways to access the returns offered by the property market and hedge exposures without trading in physical assets," says Henry Ann, head of new business at Tullett Prebon.

JP Morgan joins Bloomberg SwapTrader

JP Morgan is the latest investment bank to provide prices through SwapTrader, Bloomberg's multi-dealer euro interest rate swap dealing platform for end-users launched this year, signalling a further move towards electronic trading of swaps.

As with Thomson TradeWeb's own multi-dealer platform, which JP Morgan already uses, SwapTrader employs a request-for-quote system where the user requests up to three price quotes from different dealers for any given swap it wishes to trade. SwapTrader will be free for existing Bloomberg users.

"As derivatives become more transparent, more liquid and more efficient to execute, we expect this to attract new clients such as real money asset managers into the derivatives market, and for them and existing users to transact in increasingly significant size," says Michael Davie, chief operating officer for European credit and rates at JP Morgan in London.

SGX teams up with CBOT

The Singapore Exchange (SGX) has teamed up with the Chicago Board of Trade (CBOT) to establish a commodities derivatives exchange in the city-state.

The SGX and the CBOT have signed a memorandum of understanding (MOU) that "allows the two exchanges to explore the development of futures and options-on-futures contracts on Asian-based commodities potentially to be traded on the CBOT's electronic trading platform," the SGX says in a statement.

The commodities exchange is expected to start operating in the first half of 2006. "Our recent experience in successfully launching a commodity product with international delivery points, in combination with SGX's expertise in regulatory and clearing processes in Singapore, will enable us together to deliver innovative products and services to meet the expanding demand for liquid risk management tools in Asia," says Bernie Dan, president and chief executive of the CBOT.

The MOU with the CBOT puts the SGX one step ahead in the competition among the region's exchanges to develop expertise in commodities trading.

So far, the CBOT's agreements with other Asian exchanges are limited to information sharing or trading of singular products. For example, the CBOT and the Tokyo Grain Exchange have had an agreement since March 2004 for the two to share information about new products and co-operate on marketing.

In November 2004, the CBOT and the Sydney Futures Exchange agreed to develop new products in financial futures and options.

JP Morgan develops collateral management system

JP Morgan has developed a collateral management service called JP Morgan CommanD. CommanD handles collateral custody and also covers post-trade functions, including over-the-counter derivatives valuation, reconciliation, credit support annex management and liquidity management.

JP Morgan has aimed the product at institutions that want to increase their presence in the OTC derivatives market but are deterred by the expense and difficulty of setting up their own in-house collateral management procedures. These include corporate clients, small and medium-sized investment banks, governments and hedge funds, the bank says.

"Collateral is well understood as a means of reducing credit exposure, but for many financial institutions managing collateral is costly and proves a drain on resources," says Murray Brown, head of derivatives collateral management at JP Morgan Worldwide Securities Services in New York. "JP Morgan CommanD was developed as an agency solution to help clients more effectively handle the collateral process as they continue to grow their OTC derivatives book."

CommanD enters a busy market: Algo Collateral from the Canadian company Algorithmics has more than 60 institutions as users, while SunGard, Lombard and others have also moved to supply the growing demand for collateral management systems. The International Swaps and Derivatives Association estimates the amount of collateral in circulation grows at an average of 43% each year.

DTCC expands into new products

The Depository Trust & Clearing Corporation (DTCC) has expanded its Deriv/Serv matching and confirmation service to provide support for trades in interest rate swaps and swaptions, equity swaps and variance swaps.

Deriv/Serv will start supporting trades in interest rate swaps and swaptions immediately, with equity and variance swap support available in September. It will provide real-time matching and confirmation, as well as handling new trades, full or partial terminations, increases, amendments and exits.

Janet Wynn, DTCC's Deriv/Serv managing director and general manager, says the company's 23 major dealer clients would benefit from higher trade confirmation rates. Use of the service will continue to be free to buy-side customers, she adds.

Deriv/Serv already covers credit default swaps (CDSs) and CDS indexes; it added equity index options and equity options in September last year. The introduction of the new capabilities has been delayed from an original target in-service date of December 2004.

Icap uses DTCC

UK inter-dealer broker Icap will use the Depository Trust & Clearing Corporation (DTCC) for post-trade processing of credit default product transactions from September.

Icap says the move is in response to demand for more rapid and efficient processing of inter-dealer trades in credit default swap products. The link between the companies will become active in September, following system testing.

Gary Smith, Icap managing director responsible for credit default products in London, says: "The industry is working to improve the post-trade process for credit default products, and we can address that requirement by developing this link with the DTCC."

Smith adds that the majority of banks active in credit default products are already connected to Icap's post-trade systems. "We are leveraging this connectivity," he says.

Improving post-trade processing was highlighted as a key issue for the industry in the Counterparty Risk Management Policy Group report, published in late July and led by Gerald Corrigan, a managing director at Goldman Sachs and former head of the New York Fed.

CME posts record volumes

The Chicago Mercantile Exchange (CME) saw record trading volume in the second quarter of this year, up 33% from the corresponding period in 2004

Net revenue for the quarter was up 28% to $239 million, and net income rose by 44% to $82 million. The exchange credited "significantly increased trading volume" for the improved financial results.

Trading continued to shift to the Globex electronic trading platform, with 3.1 million contracts traded electronically in the quarter, or 71% of total volume, up from 66% in the first quarter of the year.

CME chief executive Craig Donohue attributed increasing numbers of trades in eurodollar futures and foreign exchange for the improvement in results. "We anticipate further electronic growth as we continue to improve the functionality of our CME Globex platform and the flexibility of our product offerings," says Donohue.

"These enhancements enable our customers to use more sophisticated trading strategies and increase trading in new electronic options products."

MarketAxess sees Red

MarketAxess, a New York-based multi-dealer trading platform, has subscribed to Markit's Reference Entity Database (Red) service for its credit derivatives index trading system, which is expected to launch in September.

MarketAxess will use Red data to facilitate the execution of transactions of the standard iTraxx and Dow Jones CDX contracts and will provide straight-through-processing via the Depositary Trust and Clearing Corporation, which should reduce operational risk.

Red holds a list of standard reference entities and reference obligations agreed by market participants, which has helped to ease liquidity in the single-name credit default swap market.

CME to launch inflation futures contract

The Chicago Mercantile Exchange (CME) is set to launch a European inflation futures contract on September 19 based on the eurozone harmonised index of consumer prices (HICP) excluding tobacco, an annual inflation measure published by Eurostat. The contracts will trade on the CME Globex trading platform between 8am and 4pm UK time.

In designing the specifications of the contract, the CME has responded to criticisms of its US consumer price index (CPI) futures contract, which has failed to get off the ground since its launch in February 2004. The European contract will be based on a notional value of e1 million for 12 months, and will be quoted as 100 minus the annual inflation rate in the 12-month period proceeding the contract month. The US contract uses quarterly inflation, which has been criticised by dealers as introducing too much seasonal volatility.

"The contract's monthly expiry will generate interest from inflation swap desks at major banks, as well as asset managers and active traders like hedge funds looking for trading opportunities," says Robin Ross, managing director of CME interest rate products. "An active short-term inflation hedge will allow dealers to free their capital to create more structured products of medium- and longer-term tenures, thus contributing to the further growth of the European inflation derivatives market."

Whereas Barclays Capital was the only market-maker for the US contract, the CME anticipates it will have several market-makers when the HICP futures are launched. The exchange is offering a six-month fee waiver for Globex and clearing fees to all market participants at launch.

Eurex to list futures on volatility indexes

Eurex, the Frankfurt-based derivatives exchange, is to launch futures contracts on implied volatility. The contracts will be linked to three volatility indexes it launched earlier in the year, covering the European, German and Swiss markets. The contracts will be launched on September 19, covering the three nearest calendar months and the next quarterly month of the February, May, August and November cycle.

Axel Fischer, senior product manager at Eurex who was in charge of the contract, says it was mainly driven by investor demand. Growth in the variance swap market – which now sees e15 billion notional traded every year – prompted the exchange to look into the volatility futures market, revisiting an asset class it left in 1998 after its ill-fated Volax contract – a volatility future on the Dax – was pulled due to low liquidity after less than a year.

Eurex decided against doing a straight variance product because it felt end-users would prefer a simpler product. "It might compete with variance swaps in some areas but it's mainly an alternative because the focus is on hedge funds, pension funds and fund managers in general, while the variance swap market is a pure over-the-counter market focused on sophisticated hedge funds," Fischer says.

Fischer notes that the future has three main uses: directional trading; spread trading between futures on the three European volatility indexes and the Vix future listed on the Chicago Board Options Exchange; and risk management for benchmarked fund managers hedging against a rise in volatility.

Ralf Dreyer, head of product development at Eurex, says the exchange expects to launch more products in this area in the near future, but wants to build liquidity in these contracts first to ensure their success. "The liquidity in the underlying options is the main driver here, and as soon as we identify enough liquidity in other options products where there is also enough demand for volatility, we will consider listing them," he says.

The volatility indexes – VStoxx, new VDax and VSMI, linked to volatility on the EuroStoxx 50, Dax and SMI indexes respectively – were launched in April this year.