By Byron Baldwin, Deputy Global Head, Fixed Income Trading & Clearing Sales at Eurex
A new innovative and versatile ETD offering efficient Leveraged Access to European Corporate Bond Market Beta while Generating Alpha
“Banks under the traditional broker-dealer model are less willing to intermediate and hold risk on their balance sheet. Instead, they are moving towards a more riskless type of business model, where they get compensated for facilitating trades, often referred to as agency trading. Under this regime, low and stable bid ask spreads are becoming less meaningful as a liquidity metric, given that investors typically have to sacrifice immediacy and delay the trade until the broker-dealer has found the other side of the market.”’
– Vasiliki Pachatouridi, BlackRock, “Addressing market liquidity: a broader perspective on today’s Euro corporate bond market” [1].
Introduction: In September 2017, Eurex launched the innovative EURO STOXX® 50 Corporate Bond Index Futures (CBIFs). Based on the EURO STOXX® 50 Corporate Bond Index, it is the world’s first exchange-traded corporate bond index derivative. With the new capital regulatory requirements reducing banks’ inventory of cash corporate bonds for market-making purposes, the new Eurex EURO STOXX® 50 CBIF give both the buy side and the sell side a very capital-efficient tool [4] as well as leveraged access to European corporate bond market beta while creating new opportunities to generate alpha.
EURO STOXX 50 Corporate Bond Index – an overview: STOXX launched the EURO STOXX® Corporate Bond Index in April 2016. The index is based on the corporate bond issuance of the companies that constitute the EURO STOXX® 50 equity index. Currently, 271 corporate bonds from 30 companies make up the index. To be included in the index, corporate bonds have to be denominated in euros, have a fixed or zero coupon, and been classified as investment grade (consolidated rating of BBB or higher) with at least fifteen months to maturity, measured from the respective rebalancing date with a minimum outstanding of EUR 750 million. The index is calculated every minute in real time between 9:00 and 17:15 CET. Index weights are calculated according to the market cap of the bonds, capped per issuer (20%) and by industry sector (40%).
Diagram 1: EURO STOXX 50® Corporate Bond Index – an overview*
Eurex EURO STOXX® 50 Corporate Bond Index Futures (CBIFs): The Eurex EURO STOXX® 50 CBIF is a cash-settled index future with quarterly expiry based on the EURO STOXX® 50 Corporate Bond Price Index. Currently, (see diagram 1 above), the underlying index has a weighted average duration of 4.99 years which translates to a BPV of 0.0531 and a weighted time to maturity of 5.417 years. Compare this to the December 2017 EURO Bobl Future CTD, currently the DBR 1.75% July 2022, of just under five years and a BPV for the December 2017 EURO Bobl Future of 0.06199. The Eurex EURO STOXX® 50 CBIF has a contract value (index futures price x EUR1,000) close to EUR100,000
– similar to the notional value of EURO Bobl Futures – and it has a minimum trade size of 100 lots for the block trade facility to trade off exchange. As it has the structure of a standard Eurex index future, the EURO STOXX® CBIF can be easily added to the existing risk and trading infrastructure of the buy side and the sell side.
Diagram 2: EURO STOXX® 50 Corporate Bond Index Futures – contract specifications
Generating Alpha: The launch of the EURO STOXX® 50 CBIF opens up a new relative value alpha generating trading opportunity as credit trade (see diagram 3 for the EURO STOXX® 50 Corporate Bond Index vs Front Month Eurex EURO Bobl Future). The maturities of the two contracts are very similar – the December 2017 Bobl Future currently has a CTD of the DBR 1.75% July 2022, i.e. just under five years, while the EURO STOXX® 50 Corporate Bond Index has a weighted maturity of 5.41 years. The EURO Bobl Future / EURO STOXX® 50 Corporate Bond Index Future credit spread can be structured and executed off exchange using Eurex’s T7® trade entry services “Block Trade” [5] and “Exchange for Physical (EFP) – FI facilities”[6]. The EURO STOXX® 50 CBIF has a minimum block trade size of 100 contracts – so executing the CBIF via the block facility becomes the qualifying transaction against which to execute the Eurex EURO Bobl Future in the EFP-FI facility.
The Eurex EURO Bobl Future / Corporate Bond Index Future credit spread trade should be structured in terms of the ratio of the BPV of the two respective contracts.
Diagram 3: Front Month EURO Bobl Future versus EURO STOXX® 50 Corporate Bond Index
Another alpha-generating trading opportunity exists as correlation trade of the EURO STOXX® 50 CBIF vs the Eurex EURO STOXX® 50 Equity Index Future (see diagram 3 below).
Eurex’s trade entry services “Block Trade” and “EFP-index facilities” [7] can be used to structure and execute the Corporate Bond Future / EURO STOXX® Equity Index Future correlation trade off exchange. The minimum block size for the CBIF is 100 lots – one can execute the EURO STOXX® 50 CBIF on the block facility which then becomes the qualifying transaction against which to execute the EURO STOXX® 50 Equity Index Future on the EFP-index facility. To structure the EURO STOXX® 50 CBIF / EURO STOXX® 50 Equity Index Future spread, one approach would be a structure in terms of the value of the price risk of the two respective futures contracts.
Diagram 4: EURO STOXX® 50 Corporate Bond Index versus EURO STOXX® 50 Equity Index
Efficient Portfolio Management: The Eurex EURO STOXX® 50 CBIF will also increase the efficiency of fixed-income (FI) portfolio management. An FI portfolio manager will be able to change the composition of his portfolio in European corporate bonds quickly and efficiently without disrupting the existing bond portfolio: For example, a manager has a European government bond portfolio; wanting to reduce their exposure to French five-year government bonds (“OAT”), they introduce an exposure to European five-year corporate bonds. By using a portfolio overlay strategy – selling Eurex OAT Futures / buying Eurex CBIFs [8], the portfolio manager is able to quickly switch the exposure from French short-term government bonds to a European corporate bond exposure whilst leaving the existing portfolio intact (see diagram 5). Once the outperformance of corporate bonds is considered to be complete by the portfolio manager, the long CBIF / short OAT Futures overlay position is unwound.
Synthetic European Corporate Bond Investment & Duration Targeting/Adjustment: Eurex EURO STOXX® CBIF can also be used to create a synthetic European corporate bond cash investment exposure with a specific duration target. Using the formula (Modified Duration x Investment x 0.0001) / BPV Corporate Bond Index Future will generate the appropriate position in Eurex EURO STOXX® 50 CBIF to create the synthetic European corporate bond cash investment exposure [9]. In
addition, Eurex’s CBIF can be used to quickly change the duration of a European corporate bond portfolio by buying/selling Eurex CBIFs from/to an existing European corporate bond portfolio. For example, looking at quickly increasing portfolio duration: (Target Portfolio Duration x Investment x 0.0001) – (Current Portfolio Duration x Investment x 0.0001) / BPV Eurex Corporate Bond Index Future. This will generate the appropriate number of CBIFs required to quickly increase duration within the portfolio.
Conclusion: Eurex’s innovative EURO STOXX® 50 Corporate Bond Index Futures (CBIF) – the world’s first exchange-traded corporate bond futures contract – will give asset managers an efficient leveraged access to European corporate bond market beta in terms of portfolio overlay and allow them to quickly add and subtract European corporate bond exposure to a multi-asset / GTAA portfolio. For relative-value hedge funds, the Eurex CBIF opens up new alpha-generating opportunities in trading CBIFs vs Eurex’s EURO Bobl Bond Future as a credit trade and against Eurex’s EURO STOXX® 50 Equity Index Future as a correlation trade. For banks’ corporate and credit desks, it offers a valuable hedging and trading vehicle at a time when banks’ holdings of corporate bonds have declined due to the new regulatory capital requirements.
CBIFs are a versatile, innovative new exchange-traded derivatives instrument that meets the needs of a range of market participants in the new regulatory capital and market infrastructure environment.
DISCLAIMER This publication is published for information purposes only and shall not constitute investment advice respectively does not constitute an offer, solicitation or recommendation to acquire or dispose of any investment or to engage in any other transaction. This publication is not intended for solicitation purposes but only for use as general information. All descriptions, examples and calculations contained in this publication are for illustrative purposes only. Eurex and Eurex Clearing offer services directly to members of the Eurex exchanges respectively to clearing members of Eurex Clearing. Those who desire to trade any products available on the Eurex market or who desire to offer and sell any such products to others or who desire to possess a clearing license of Eurex Clearing in order to participate in the clearing process provided by Eurex Clearing, should consider legal and regulatory requirements of those jurisdictions relevant to them, as well as the risks associated with such products, before doing so.
Footnotes and further reading
* Data as of 3 July 2017
** As the Corporate Bond Index Future has not yet been launched, the figures used for the corporate bond index as set out in diagram 2 are for illustrative purposes only.
*** As yield levels change, so will values of BPV. Accordingly, the BPV ratio needs to be constantly managed and monitored.
- Vasiliki Pachatouridi, Assessing Market Liquidity: A Broader perspective on todays Euro Corporate bond market: https://wworld-exchanges.org/focus/index.php/features/news– views/30-addressing-market-liquidity-a-broader-perspective-on-today-s-euro-corporate- bond-market [last check on 6 Oct 2017] and: https://www.blackrock.com/corporate/en-us/ literature/whitepaper/viewpoint-addressing-market-liquidity-euro-corporate-bond-mar- ket-2016.pdf [last check on 6 Oct 2017]
- Eurex Clearing Circular 062/17: Bond Index Derivatives: Introduction of Futures on the EURO STOXX® Corporate Bond Index: https://weurexclearing.com/clearing-en/resources/ circulars/Bond-index-derivatives–Introduction-of-futures-on-the-EURO-STOXX-50– Corporate-Bond-Index/3091862 [last check on 6 Oct 2017]
- STOXX, EURO STOXX 50® Corporate Bond Index: https://wstoxx.com/index- details?symbol=SX5BTR [last check on 6 Oct 2017] and STOXX Bond Index Guide: https://www. stoxx.com/document/Indices/Common/Indexguide/bond_index_guide.pdf [last check on 6 Oct 2017]
- There are benefits to banks impacted by the new capital regulatory requirements for Corporate Bond Futures with the potential future exposure (PFE), a notional add-on based on the current-exposure method (CEM) for interest-rate futures being 0% (could change on a move to standardised approach for counterparty credit risk (SA-CCR) method):
PFE for derivatives
- Link to block trade facility: http://www.eurexchange.com/exchange-en/products/ eurex-t7-entry-services/block-trades
- Link to EFP-FI facility: http://www.eurexchange.com/exchange-en/products/ eurex-t7-entry-services/exchange-for-physicals
- Link to EFP-index facility: http://www.eurexchange.com/exchange-en/products/ eurex-t7-entry-services/exchange-for-swaps
- Need to structure the portfolio overlay strategy in terms of the appropriate number of Eurex OAT Futures to hedge/neutralise the French government bond holding and create the same duration exposure in European Corporate Bonds using the Eurex EURO STOXX 50® Corporate Bond Index Futures. See my article on LinkedIn Pulse which covers this topic: The “Future of Fixed Income Investing in a Capital Constrained World”: https://wlinkedin.com/pulse/ future-fixed-income-investing-capital-constrained-world-byron-baldwin
- As rates change, BPV values will Thus, the appropriate number of Corporate Bond Index Futures needs to be constantly managed and monitored.
- Performance comparison to other corporate bond indices
On Bloomberg, the code for the EURO STOXX 50® Corporate Bond Index Future is CBIA Index
– for a contract description for the December 2017 delivery month type CBIZ7 Index DES, see below:
Byron Baldwin, Deputy Global Head, Fixed Income Trading & Clearing Sales, Eurex
