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November 1, 2016

New Exchange Aims to Explode the OTC Market

A new exchange is in the process of launching hybrid products which will eliminate the key disadvantages of hedging rate risk on-exchange.

One of the disadvantages of hedging using the current exchange market is the mismatch in dates between the underlying risk and the exchange products available, being quarterly rolling. A new exchange plans to tackle that problem head on by developing and launching a series of hybrid contracts  which offers products in all maturities out to 30 years. The constant maturity future (CMF) has a spot maturity and never expires, with a notional size scaled to suit expected volume in the strip of maturities. The buyer of each contract is exposed to the equivalent of paying fixed, while the seller is exposed to the equivalent of receiving fixed. The CMF is quoted by rate to match the external risks and align with current IRS markets data and norms.

Speaking exclusively to The OTC Space the CEO VJ Angelo told us their strategy is to launch a number of varying contracts, using the CMF methodology, on the Eurex Exchange platform meaning traders don't need to on-board a new platform. The first of these, the Euro denominated IRS CMF is already in beta live. The trades will be cleared at Eurex and margined using VaR but benefit from the lower period of risk given to exchange products making the initial margin payments lower than the equivalent bilateral OTC trades.

In addition the CMF will be eligible for cross-margining against traditional ETD and OTC products at Eurex within their PRISMA platform, giving further risk offsets and a corresponding margin reduction. VJ also explained that the business is currently in the launch phase with euro contracts due to go fully live in the coming months, with all the necessary regulatory approvals and processes now in place.

London Derivatives Exchange is the new name for previous GMEX Exchange platform, with the GMEX business continuing to develop and deliver technology solutions having been sold to Forum Trading Solutions and Hirander Misra, LDX now having the resources and staff focus to complete the development of the CMF.

The attached press release explains more about the new company. 


LDX IRS CMF product features  (and more at http://www.londondx.com/products)

  • IRS CMF Contracts never expire, have no time decay and do not mature 

  • Trades as a rate 

  • Buyer pays fixed/seller receives fixed 

  • Notional size of contract varies by tenor 

  • Listed and traded on Eurex Exchange – no need to onboard a new trading venue 

     

Central clearing 

  • Overnight margining against settlement value of the IRS Constant Maturity Index 

  • Margin offsets against positions in other products available at Eurex Exchange, optimising the market’s leading interest rate product suite (listed and OTC), based on the whole EUR-denominated yield curve 

  • Cleared via Eurex Clearing – helping you manage risk and become more efficient with capital usage 

     

Price discovery 

  • Yield / Rates based quotes 
  • Quoted to 1⁄4 of a Basis Point 

  • Example prices: Bid = 2.0025% (Payer of Fixed) Offer= 2.0075% (Receiver of Fixed) 

     

Index based on Volume Weighted IRS quoted prices 

  • Index is streamed in real-time incorporating tradable prices from market recognised IRS trading platforms 

  • Settlement value determined by applying our methodology to tradable prices published in the last 3 minutes of the trading day 

     

Maturity calibration 

  • Maturity calibration process used to keep positions in the same maturity from one day to the next. 

  • At EOD, all positions VAR margined to the Index Settlement Value – thus Index becomes OI position price and is used to calculate the 1 day forward price 

  • OI transferred to 1 day forward price (‘maturity calibration’) with no P&L impact.

  • This removes structural cost differential of the daily change in the IRS rates. 

     

Incorporation of Carry Costs 

  • The maturity calibration process incorporates the overnight carry costs into the values of the IRS CMF. 
  • The following day the market will adjust back to the spot price. 

 

Maturities & contract provision 

  • Every annual maturity from 2 – 30 years 

 

Convexity 

  • Closely replicates IRS convexity
  • Tick Value calculated using OIS discount curve 

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