In the seven years since it launched, Chicago’s Eris Exchange has carved out a niche as the futures market’s sole credible alternative to over-the-counter interest rate swaps. Virtually all the large exchange groups have tried and failed to establish a liquid OTC-lookalike contract; some attracted big-name market-makers, only to see liquidity plateau; others never saw more than token trades.
Eris now claims a 70% share of all swap futures open interest globally, with its pool of open contracts still growing at a clip of more than a third this year, hitting a recent peak of 204,741 ($20.5 billion notional).
Eris claims its unique product design – its contracts seek to match the cashflows of OTC swaps, but in a futures wrapper, meaning they require significantly less margin to back them – are the key driver of its success. But the very nature of its contracts leaves it with a problem: an end-user can buy a swap future and hold it till maturity; but unlike in the OTC market, the buyer is left without a real-time pricing curve from which to mark its book as the product rolls down over time.
That creates a hurdle for real-money players – pension funds or fund-of-funds managers, for instance – that might otherwise flock to the product. The exchange has been wrestling with this problem for some time, and thinks it’s found a solution.
Geoff Sharp, the Chicago-based exchange’s head of sales, says: “Because Eris contracts exactly replicate the cashflows of the analogous OTC swap, they are convexity-neutral with OTC swaps: they don’t need to deliver, expire or roll to maintain economic equivalency. That means liquidity and positions get spread across off-the-run contracts; for example, there are all these old 10-year contracts with different start dates still out there with a portion of open interest. That’s actually incredibly valuable; it means someone can get into a swap at the tenor they want, in a liquid order book, and they can hold it for the life of the underlying swap against a bona fide exposure on the other side. But the challenge is, how do we mark these every day?”
That’s where the exchange’s Live Eris Swap Curve comes in. Launched in March, the bourse has painstakingly built a proprietary curve by bootstrapping live executable prices across its swap futures complex.
“Eris has essentially taken the order book prices of the front contracts of all its central limit order books and fitted the curve. In doing so, we create discount factors all the way out to 50 years to be able to price the swap curve,” says Sharp.
The bourse has also begun streaming and fixing a daily spot rate, implied from the live curve, which clients can use as a benchmark for their exposures.
Our priority now is certainly more liquidity out across the order books. But the real focus is on client acquisition and diversification. We’re always very cognisant of client diversificationGeoff Sharp, Eris
“You can trade the prices used to mark your model. This is completing the circle of us saying, several years ago, ‘Wouldn’t it be great if we were able to offer all of the tools people have built over the last 20 years in the OTC market for our own product?’ And now we have,” says Sharp.
Neal Brady, Eris chief executive, says the curve has already had a bearing on its bid to get more real-money clients onto the platform and using its products.
“The Live Eris Swap Curve makes our product very tangible,” he says. “We can offer all the analytics people are used to seeing in OTC, but based on tradable limit order book prices. That’s what’s driving take-up: we’re seeing a bunch of real-money hedgers who need these tools to mark their books come in and put on hedges, and allowing them to roll down the curve. We’re also seeing guys who trade more passively through algorithms, from the asset management side and hedge funds, start to use it; they like it because they can lean against the order book, which they can’t do in OTC swap markets.”
The bourse says it is actively engaged with a large number of real-money clients, several of which it expects to onboard next year. But perhaps the biggest inhibitor to the hockey-stick growth Eris and its backers hanker for are factors outside its control – including a continuing lack of support from some of the largest brokers in the futures business. Names like Barclays, Goldman and JP Morgan are still conspicuous by their absence from Eris’s roster of supporting futures commission merchants (FCMs).
We can offer all the analytics people are used to seeing in OTC, but based on tradable limit order book pricesNeal Brady, Eris
What Eris can control is its diversity of clients, moving away from its early reliance on its market-maker backers and establishing genuine two-way flow. Here, the stats appear to bear out claims its strategy is working.
“Our priority now is certainly more liquidity out across the order books. But the real focus is on client acquisition and diversification. We’re always very cognisant of client diversification. It’s not good having a bunch of market-makers just trading with each other. It’s important to get ‘paper’ into the market: users looking to lift and hit prices and establish risk positions, or get out of exposure they have elsewhere. One of the things we’ve observed over the past two years is a migration from 60–70% of flows being dealer-to-dealer, to about 10% today. The lion’s share of activity is now a dealer transacting with an end-user,” says Sharp.
For the exchange’s supporters, the contracts’ economics are a no-brainer. “I’ve been banging the drum on this to clients for five years now; unless you’re a corporate, I just don’t get why you’d use swaps any more. It might take another five years, but I’m confident everyone will see the light,” says the head of fixed income at one non-bank FCM.