What new products is OneChicago currently working on?
In conjunction with our securities lending focus, we are rolling out short-term, weekly contracts. There are two features to these contracts that make them unique. First, the weekly futures are listed and expire daily. In other words, on each day there is a future being listed that morning (and set to expire in one week) and a future expiring that afternoon (that was listed a week ago).
The second feature of these contracts is that upon expiration, they settle into cash the next business day, on T+1. Parties who are looking to transfer their stock can use our product to do so and simultaneously enter into an exchange-traded derivative that replicates a total return swap. They can carry that position, in a centrally cleared way, completely protected by the guarantees of the Options Clearing Corporation (OCC) and the National Securities Clearing Corporation (NSCC).
Current securities lending transfers are conducted through the Depository Trust Corporation (DTC), which is not a central counterparty (CCP). Critically, this means that they do not guarantee performance between the two parties and that is what leads to failures to deliver.
As you can see, the two features that we can offer are completely absent from the current securities lending world. Going through the OCC and NSCC guarantees performance, as there has never been a failure to deliver through its process. And the trading is done in a competitive transparent manner. These combine to make this is a better way.
There has been a lot of talk about the securities lending market not being able to use CCPs, and the reason is because they do not handle bilateral transactions. The way we function is cheaper for clients, acts to upgrade counterparty exposures for everybody and allows people to act independently of each other inside a regulated, transparent, CCP-protected exchange.
What prompted this and how do you anticipate it will affect business?
The prime brokerage space deals with hedge funds, which are looking for leverage and financing. They get this by using swaps, but can also do this with a future. A single stock future (SSF) is a total return swap, but it is transparent and regulated—which is what scares the firms, as they make a lot of money due to the lack of transparency in these markets.
The volatility in the rates indicates that there is no efficiency in those markets, and prime brokers have always been wary that, if customers begin to use a transparent market, then their profits will be compressed.
This also means that the prime broker intermediaries could be at risk of being pushed out of the marketplace.
In the last 20 years, intermediaries have been gradually phased out with the technological revolution in which buyers and sellers, and lenders and borrowers, can interact in real time, using electronic access.
Securities lending is no different. The only markets that are yet to move this way are the equity markets, and that is where we stand. We maintain, as a substitute for an equity swap, market participants should be using securities futures, which are economically identical to a total return swap.
I have no doubt that, as the new world characterised by Basel III comes into being, people will be looking for new ways to accomplish these critical market processes—and will turn to exchange-traded products to do that. This is where OneChicago stands.
We have used feedback from regulators and customers, and lessons from the events of the late 2000s to shape our contracts.
Has there been any improvement in the uptake of SSFs in recent months? If so, what is to thank for this?
Equity derivatives have generally been depressed across the board, the only one that has done well in the US is the interest rate markets. The fact is that the product has maintained its momentum, it’s just not growing in leaps and bounds. Again, we are yet to break into the real market—securities lending will eventually move onto an exchange with CCPs, and that is what we are waiting for.
There is something of a lull in the marketplace overall at present, particularly in terms of stock loan borrow activity. Everyone is going through structural changes and this is affecting liquidity in the marketplace. However, this will come back—the markets always come back.
In particular, the use of the SSF based on exchange-traded fund underlyings have been very popular of late, as customers are able to get leverage and financing for whole sectors of the marketplace and not just one stock.
What deterred people from using SSFs in the past? Is this attitude likely to shift in the future?
The only way to get access to SSFs is through an OCC member, and those are primarily the prime brokers.
As I discussed, prime brokers make their money by putting customers into total return swaps and charging them for their balance sheet usage. SSFs are competitive in nature, and in order to get access, one of the prime brokers must allow it—generally, there are exceptions, none of them currently allow their customers access to the product.
This is because it competes with the way they make money, in a non-transparent manner. We believe that they will come to the realisation that customers can fulfill their trading needs inside the safety of a regulated exchange, protected by a CCP, with the luxury of being able to cut that middle man out of the equation.
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