In an interview, Pam Finelli and Fadi Chamsy from Deutsche Bank’s synthetics team explored on the MSCI derivatives from different angles. The second session reveals where they see the potential of our MSCI offering with respect to regulatory aspects and the market climate in general.
The first session focuses on how the Eurex MSCI offering fits into Deutsche Bank’s business landscape, on crucial trading strategies and the benefits of on screen trading. Click here to get there.
Eurex: We increased our MSCI offering this year to cover 25 different indexes. For which ones do you see the most potential, both in your day-to-day business as well as in the general marketplace?
Fadi: It will be the indexes which are most difficult to track. Replicating the performance of MSCI EM, and to a lesser extent MSCI World and MSCI Europe, using baskets of futures or stocks is difficult and restrictive for many investors who may not have the ability to trade in some markets or the infrastructure to construct cross-country cross-currency portfolios. A packaged instrument will mitigate most of these risks.
Pam: Asia Pacific ex Japan is another key one, I would say those four are where you will see the highest uptake and liquidity.
Eurex: Will they get to a point where the single countries products become very liquid?
Fadi: I think the liquidity will be concentrated in the regional indexes. Benchmarks such as MSCI World, MSCI Emerging Markets and MSCI Europe are widely tracked indexes which appeal to a very broad investor base. There may be some interest in country MSCI indexes but I think this will be limited to markets that are otherwise difficult to access and likely to be focused around macro events.
Eurex: You mentioned the futures have seen quite a good uptake. What’s your view on the options?
Fadi: I don’t think there’s necessarily less interest. We’ve seen less pickup on the options side but MSCI options have been traded OTC for years. Futures have been listed for a few years now on different exchanges and investors are only starting to look at these instruments as a viable trading option. Once the liquidity increases in futures and investors are comfortable with the products then trading options is the next step. We believe the Eurex MSCI option offering is robust. It is always a question of first mover. No one wants to be the first to trade but when liquidity is there then the interest naturally increases.
Pam: The listing of the options is a big selling point for some clients, because it does match up with their benchmarks and some clients would be more likely, especially on the options side, to trade a listed product rather than OTC. I see a lot of interest in the options that line up with where investor benchmarks are - this is a great product for our clients
Eurex: With the regulations coming in, principally around EMIR, DFA, do you see clients making that shift to the listed side already, or are they favouring more of a holding position at the present?
Fadi: It is the investor’s restrictions and needs that will dictate the choice of the instrument rather than the listing. Ultimately we view all instruments as wrappers. If the same wrapper is available in a listed format then the choice is clear. That said, many clients continue to use OTC instruments, particularly when holding large static positions. Regulation may force certain investors to shift to listed instruments but when the choice is readily available, that shift has already happened.
Eurex: We just calculated the potential margin offsets, and we took a standard portfolio – EURO STOXX® 50, DAX®, options, single stocks – and we added the more liquid MSCI indexes and realized you can save up to 50 percent in margin offsets. It was surprising to us as well, but we can confirm for all portfolios there is a very large margin offset* which could be a major selling point.
Fadi: The margining is definitely another selling point. I think one other point we haven’t touched on is that the more liquid these instruments become, the better the pricing becomes. That’s a key factor for a lot of investors. We wrote a note back in November of last year where we looked at some of the MSCI derivatives – we were quoting indicative bid/ask spreads of about 150 basis points. When we published around the same topic in March of this year, the spreads on the same instruments were down to 60 bps. So we safely say that liquidity has driven spreads narrower, and as spreads narrow liquidity will increase – if we continue this feedback trend we should expect a significant increase in liquidity.
Eurex: We keep hearing about the uncertainty in the wider economic climate. How do you see these index products developing in this context?
Fadi: In the last couple of years we have been in a low volatility environment, where tracking has been easy. If you’re tracking a portfolio with a basket of stocks or indexes or futures, you actually did well. Volatility was low except for a couple of spikes in 2010 and 2011. If we ever get to a high volatility regime or if we get more frequent volatility spikes, investors will start to get worried. Reducing tracking error, slippage and execution risks becomes a major concern. This is when the benefits of MSCI derivatives become clear.
Eurex: Is there anything we could improve about our product?
Fadi: We spoke about pricing and I believe that will improve as liquidity increases. I think the focus should be on the settlement price methodology which is extremely important to clients for their risk management.
Eurex: Has there been different kinds of feedback from different clients? For example, how has the response been to these products in other markets such as the U.S. or in Asia?
Fadi: I wouldn’t say so. Our client base is global and we have had interest both from U.S. and European clients in the Eurex product. Many U.S. investors trade the mini MSCI contracts in the U.S. but the Eurex derivatives have some additional attractive features such as being based on the net return indexes removing one risk from the futures cost. Now that Eurex MSCI derivatives have received CFTC approved, I suspect interest from the U.S. should increase.
Pam: One thing I’d like to add to what Fadi mentioned about settlement prices. Settlement prices on the options are very important for us because it allows us to analyse the volatility in the same way that we can for EURO STOXX® or DAX® Options. It gives us a comparison. Liquidity will make the settlement prices more accurate. But as we’ve seen with the sector options or STOXX® sector indexes, if the settlement prices are off it makes it more difficult for us to use the listed market as the proxy for the options analysis. That’s one thing that would be very helpful for us.
Eurex: In terms of new products, what would you be interested in?
Fadi: I don’t want to look too far ahead but from what we’ve seen in terms of MSCI, the smart beta indexes, it’s early days to be listing derivatives on those but in the medium term it is something to consider.
Pam: Our colleagues wrote a piece about all the minimum volatility indexes that MSCI has. There’s a lot of interest from investors on these types of products – high dividend, min volatility – this is an area of growth for MSCI so I think these will become very tradable at some point in the future. If you look at the ETF market, we’ve seen tremendous inflows this year into low volatility indexes. It’s an interesting market to look at ETFs because you can see the fund flows. The other thing I can say is the MSCI sectors, there are some big clients that trade these actively, and are benchmarked to them.
Our job is a combination of investor education and idea driven research. Part of what we do is help our clients understand the products they can trade or the instruments that are available. For the idea-driven, more thematic pieces of research, we might tie together the views of some of our strategists have said with the product pieces, this could be something we could do with the MSCI futures. So far the feedback has been great, we have no doubt the Eurex offering is very good, and I think it’s only a matter of time before investors become more aware of these instruments.
Eurex: Thank you very much for the conversation.
*Editor’s note: On 27 May 2013, Eurex Clearing launched its new portfolio-based margin approach Eurex Clearing Prisma. Cleared products that share similar risk characteristics will be assigned to so-called Liquidation Groups, which result in more accurate risk calculations and which will enable cross margining within Liquidation Groups.The first release featured the cross margining of equity and equity index derivatives, i.e. risk of open positions in MSCI derivatives will be offset with risk of open positions in for example EURO STOXX 50® Index derivatives. The new margining method is unique in the industry as it closely aligns the default management process with actual margin methodology.