Liffe’s launch of a one month futures contract based on Eonia (Euro Overnight Indexed Average) represents a resurrection of interest in the instrument at a time when funds and other market participants are becoming increasingly inclined towards exchange-based options. The contract was, originally, listed on Liffe in February 2003, but rather than simply resurrect it in its original form, consultations by the exchange revealed that a new version ought to have modified timing parameters that would be far more relevant to cash managers. The new contract went live on 16 June on Liffe, and is being referenced to the Eonia rates, calculated each night by the European Central Bank. In addition, Liffe has launched a three month Eonia swap index futures contract. Large fixed income launches of this kind don’t come along very often, but this one seems to have gathered plenty of momentum in the market (see Fig.1).

The one month Eonia contract has an accrual period in line with central bank reserve maintenance periods, providing a cost-effective means of gaining or hedging exposure to overnight euro rates. It represents a centrally-cleared, very near term interest rate futures contract targeted very much at traders looking to free up capital from Treasury, repo, and reverse repo trades who are currently using the OTC market. The three month Eonia futures contract will be referenced to the Three Month Eonia Swap Index, sponsored by the European Banking Federation. It will settle in line with IMM (International Money Market) dates, and offers a spread trading opportunity against the established and already liquid three month Euribor futures contract.

Apart from wholesale trading facilities, Liffe is providing block trading, asset allocation, and basis trading for the contracts. Both contracts offer hedging and exposure opportunities for all forms of money market trading, including repo and reverse repo, short term swaps and treasury management.

Tight market conditions

According to Garry Jones, Executive Director of Business Development and Strategy at Liffe, tight market conditions in both the euro and sterling short term money markets have prompted the launches. Liffe has been seeing a large and volatile spread opening up between Eonia and other major benchmarks, like Libor and Euribor. Whereas the spread has traditionally been predictable, it has now become less so, prompting a need for an on-exchange, centrally-cleared Eonia futures contract.

Reverse repo cash managers have been telling Liffe that in order to represent a better hedge, the contract should be tied to reserve maintenance periods (i.e. European Central Bank meeting dates rather than actual pre-specified calendar dates).

This is where fund managers are lodging their cash during these reserve maintenance periods. The three month Eonia swap index fixing was also client driven in its specification.

“The three month contract is exactly the same notional and tick value as Euribor,” explains Paul MacGregor, Director of Fixed Income Business Development at Liffe. “It is settled on the same dates as Euribor, so it mirrors the contract and sits alongside it.”

As a consequence, it offers a spread-trading opportunity between the two, along with an alternative hedging mechanism for clients who see the Eonia swap index as a more relevant hedge than Euribor.

Achim Kraemer, Deutsche Bank’s Head of Continental European Interest Rate Risk Management and a member of the ACI Derivatives Working Group, says there has been a strong focus in the market on Eonia swaps recently and the time is ripe for the launch of a contract of this kind. “People want to be positioned here,” he explains. “This is an instrument that enables counterparties to position themselves, and the fixing reflects the liquidity premium. It is both attractive and interesting for us.”

Incentives available

Liquidity has been reasonable so far. The exchange has three permanent market makers with several large firms, amongst them hedge funds, signed up to be liquidity providers. They don’t have obligations to quote but will be rebated 15 pence on every trade, incentivising them to trade. A number of large brokers have also expressed interest in the wholesale facilities (block trading, basis trading and asset allocation in particular). The block trading threshold is 500 lots, considered reasonably low when compared to an existing Euribor threshold of 3,000 lots. The incentive is there for brokers to package up the business and still gain the benefits of central counterparty clearing. The asset allocation trade is particularly interesting, allowing traders to take out an equal and opposite position to different contracts, e.g. Euribor against Eonia with a guaranteed spread built into the product. Currently there is no threshold on this trade and a number of large brokers have now set themselves up to provide this trade, paving the way for what MacGregor expects to be “some quite serious moves into the product.”

“We’re very excited, it’s a big launch for us, and we’re reasonably pleased with the early indications,” he says. “We’re also in discussions with three additional potential market makers. We’ve been told by clients that if there was a time for an Eonia product to succeed on the exchange, that time is now, simply because of market conditions and the desire for the investment banks to trade on exchange wherever they can rather than on OTC.”

Although no similar options’ contracts are currently available, the fact that the futures are up and trading makes a big case for an options’ launch later this year. Deutsche’s Achim Kraemer says that as banks and fund managers adjust to the new credit market circumstances, derivatives of this nature will accrue further momentum. “Everycrisis goes through stages, and going forwards, we’re going to see more focus on deals like this,” he says.

Conclusion

There is a huge and liquid OTC market in these products and a desire by investment banks to move a significant proportion of that liquidity on exchange. Central counterparty clearing, variation margin, cross-margining between a Euribor and Eonia position, reduces risk and the amount of risk held on the balance sheet quite significantly. In today’s financial climate, that is pretty relevant.