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Structural change on the derivatives market

12 Dec 2017

Structural change on the derivatives marketThomas Book, CEO of Eurex Frankfurt AG

Another 26 days, then it finally begins: the Markets in Financial Instruments Directive (MiFID II) enters into force. It starts the probably largest structural change that Europe's derivatives markets have ever experienced after years of preparations. Ten years after the onset of the financial crisis, we thus come an important step closer to the G20's aim of making markets safer and more transparent.

That's good news. Ultimately, Europe is facing a period of massive change. Brexit and changing relationships with important trading partners such as the USA, Russia and Turkey are causing considerable uncertainty. And particularly in times such as these, stable and resilient markets are of considerable importance.

Futures replace swaps

What does the impending structural change mean for an exchange such as Eurex? Well, for a start, the regulatory agenda supports our business model. This is because it promotes a transformation of the derivatives markets that is to the advantage of central infrastructures and electronic trading. What  exchanges have always stood for – central pricing in an open order book – will now be anchored by regulation as the envisaged target on the derivatives market as well. Overall, legislators want to bring the largest possible parts of the futures market onto regulated platforms. To do this, legislators are also using other regulations in addition to MiFID II, such as the Capital Requirements Regulation (CRR), which – to put it simply – increases the capital costs for the OTC derivatives business. That creates considerable cost pressure and consolidation pressure in the financial sector and increases demand for exchange-listed alternatives.

On Eurex, we are developing new instruments in this environment in ever shorter innovation cycles. The new instruments are “simpler” both operationally and in risk implementation compared to the still dominant bilaterally traded derivatives. And, more importantly still: they are cheaper in comparison.

Hardly any product better shows what the transition from bilateral business to transparent trading in the open order book might look like than our Total Return Futures, which swap returns on equities for interest income. With this product, we offer an exchange-traded replacement for bilaterally traded total return swaps. Since their introduction a year ago, we have managed to migrate 10% of the OTC market to our product.

Together with major banks, including BNP Paribas, we ensure robust pricing in the transparent order book every day. The Total Return Futures are thus one of the first examples of “futurisation”, a long anticipated trend in which futures replace swaps in the long term.

With this and other new offerings, such as Corporate Bonds Futures, we support our customers amid the massive challenges that they have to master in order to remain competitive. In this area, it hasn't just been about banks for a long time now. Since the financial crisis, the importance of other market participants has grown significantly. Increasingly, it is specialised proprietary traders and market makers that fulfil institutional clients' needs and requirements. We therefore regularly emphasise the necessity of proportionate regulation of these companies – ultimately, they are increasingly making an important contribution to economic growth in Europe. And in view of what we face with Brexit – the drawn-out negotiations are concerning – each and every contribution to economic growth is necessary. The fact that Brussels is intensively discussing the capital markets union and deepening the economic and monetary union is a good sign. An integrated, well-functioning financial system is essential to this end. Stable, efficient and transparent derivatives markets are a part of this. They're an important precondition for sustainable economic growth.

The financial centre Frankfurt plays an important role in all these issues. Here, we work together with our customers and with regulators to drive the transition that regulators want of OTC business to the stock exchange. The innovation and “engineering” behind new products such as Total Return Futures take place in Frankfurt and are exported from there to the world.

Integrated business model

At the same time, our product range supports investors from all over the world with their investments in the euro zone. Without the opportunity to manage risks efficiently, hardly anyone can transfer capital any more these days. We provide this opportunity and thus contribute to the attractiveness of Europe's capital markets. As a stock exchange regulated in Germany, Eurex stands for transparency, liquidity and global connectivity like practically no other futures exchange.

Our integrated business model with trading and clearing – and within Deutsche Börse Group also with collateral management and index business – offers competitive advantages particularly in regard to product innovation. Compared to horizontal models, we can approach innovation in a holistic manner.

Through it all, our focus is always first and foremost on system stability. Our innovations primarily target strengthening market integrity. That happens particularly through transparency. Change does not happen overnight. The path we have embarked on from OTC traded derivatives to a central, transparent order book is a long one. But we can steer it through product innovations with new market models, direct access models for institutional clients and efficient risk models or new market models and thus do all we can to support the regulatory agenda.

The article was first published in the Börsenzeitung on 8 December 2017

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