CBOT Invoice Swap Spreads
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- Barnaby Barrett
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1 CBOT Invoice Swap Spreads New enhancements & efficiencies coming June 6, 2016
2 CBOT Invoice Swap Spread Update and Enhancements On June 6, CME will offer new functionality for CBOT listed invoice spreads to facilitate package execution of calendar rolls and tenor switches and further support relationship-based execution Invoice Spreads are a highly capital efficient method of achieving swap spread exposure Invoice Spreads between Treasury Futures and related, Forward-Starting Interest Rate Swaps are an active market, trading approximately $5 billion notional per day. Both the swap leg and the futures leg are off balance sheet, as opposed to swap spreads where the cash Treasury leg consumes balance sheet and increases cost to trade as a result of related regulatory capital requirements. Portfolio margining between futures & CME cleared swaps provides up to 80% margin savings vs. separately cleared legs. Easy P&L tracking as forward start matched dates eliminate accruals and create similar roll-down in swap and CTD yields. CBOT-listed Invoice Spreads provide an additional method of trading invoice spreads In addition to trading via EFRP, invoice spreads can be traded on the CBOT designated contract market as an intercommodity spread between the Treasury Future and the Interest Rate Swap. Product design retains historical trading conventions: swap effective/maturity dates match the CTD, swap notional maintains approximate DV01 neutrality with Treasury Futures, and swap fixed rate is traded as a basis to the CTD forward yield. New product extensions will expand spread types and access to the 10-year point NEW Calendar Spreads between sequential months (e.g. Jun16 5-Yr Invoice Spread vs. Sep 16 5-Yr Invoice Spread) NEW Tenor Switches between Treasury invoice spreads (e.g. Jun16 2-Yr Invoice Spread vs. Jun16 30-Yr Invoice Spread) NEW Ultra 10-Year (TN) Invoice Spread enhances the existing suite by enabling more precise exposure to the 10-year point Flexible new execution methods will expand support for relationship-based trading Block trades are permitted in CBOT invoice spreads, calendar rolls and tenor switches and the thresholds are aligned to swap block thresholds, providing market appropriate size levels for enabling block-based execution between counterparties. NEW Committed Cross enables pre-execution discussions between two counterparties for any size transaction prior to entry into Globex as a cross order, allowing market participants to pursue relationship-driven sources of liquidity for Globex trading. 2
3 Invoice spreads provide a highly capital efficient method of achieving swap spread exposure Invoice spread daily volume averages ~$5 billion notional per day Capital constraints have reduced liquidity in the cash market, driving strong demand for cost effective, off-balance sheet products like Treasury Futures Invoice Spread provides an efficient unfunded vehicle for achieving exposure to the swap spread Regulatory requirements and liquidity trends underscore the value of unfunded products Regulatory capital requirements create significant capital cost implications for trading of securities Increased repo costs and securities margining increases further make futures a cost effective vehicle Futures liquidity and trading activity has expanded, including recent success of Ultra 10Y contract Clearing both legs off this trade together enables significant margin efficiencies Examples of margin benefits for 5 invoice spread strategies ($1 million DV01 in each strategy) Invoice Spread Strategy Margin if Cleared Separately CME Portfolio Margin Margin Savings Savings Percentage 2YR (TU) Treasury vs IRS 33,210,422 15,131,357 18,079,065 54% 5YR (FV) Treasury vs IRS 46,791,849 9,233,353 37,558,496 80% 10YR (TY)Treasury vs IRS 47,230,122 13,312,933 33,917,189 72% Treasury Bond (US) vs IRS 48,109,925 20,109,738 28,000,187 58% Ultra Treasury (WN) vs IRS 49,705,884 17,079,356 32,626,528 66% 3
4 CBOT-listed Invoice Spreads provide an additional, regulatory compliant method of trading invoice spreads The majority of invoice spreads currently trade as privately negotiated transactions, with the Treasury Futures submitted to CME as Exchange For Risk (EFR) pursuant to rule 538. CME Group offers an additional mechanism to trade invoice spreads on the CBOT designated contract market (DCM) as a single intercommodity spread package that is compliant with regulations for futures as well as swaps subject to a trading requirement CBOT listed invoice spreads closely match existing trading conventions and results in the same two separate positions held after execution, the swap and the future. Each CBOT invoice spread listing references a specific security identified as a candidate to be cheapest to deliver (CTD) into a given CBOT Treasury Future. The future and swap are executed as a single package, traded as a spread expressed as the difference between the forward yield on the future (relative to the specified CTD) and the fixed rate on the interest rate swap The remaining attributes of the swap are all standardized to match existing invoice spread conventions, such as notional value and relevant dates (effective, maturity, and reset dates) Attribute Description Example Trading Convention Swap Notional Amount Per 1 Treasury Future Invoice Swap Spread, differential between future s delivery invoice yield and the fixed rate on the interest rate swap DV01 Weighted Value, fixed throughout the day and updated overnight if a significant move occurs 14.3 bps $104,000 (per 1 Treasury Future) Effective Date Last delivery day of the future 6/30/2016 Maturity Date Maturity of the referenced CTD 2/15/2023 4
5 Unique new functionality will enable additional package spread combinations and Ultra-10 Year Invoice Spread New invoice spread package types enable efficient calendar rolls, tenor switch trades and more precise access to 10Y swap spread point via Ultra 10-Year Invoice spread Calendar Spreads between sequential months, allowing clients with an existing invoice spread position to roll it forward each quarter. Example: Buy (Pay Fixed) Sep Year CBOT Invoice Swap Buy (Receive Fixed) Sep Year CBOT Treasury Future Sell (Receive Fixed) Dec Year CBOT Invoice Swap Sell (Pay Fixed) Dec Year CBOT Treasury Future Tenor Switches between Treasury invoice spreads enable inter-commodity spreads, facilitating relative value trading between points on the curve. Example: Buy (Pay Fixed) Buy (Receive Fixed) Sell (Receive Fixed) Sell (Pay Fixed) Sep Year CBOT Invoice Swap Sep Year CBOT Treasury Future Sep Year CBOT Invoice Swap Sep Year CBOT Treasury Future Ultra 10-Year CBOT Invoice Spread expands coverage of the curve, providing increased precision relative to the 10 year swap spread 5
6 CBOT Invoice Spreads enable market participants to trade listed products while continuing to leverage relationships Privately Negotiated Block Trading In addition to Globex trading, block trades are permitted in CBOT invoice spreads, calendar rolls and tenor switches Thresholds for both legs of the spread are aligned to match swap block thresholds, providing appropriate size levels for enabling block-based execution between counterparties Block trade participants bilaterally negotiate and execute the applicable invoice spread, determine leg prices and report the prices to the exchange within 15 minute reporting period Tenor Threshold for each leg Futures Equivalents 2-Year $460 M 2,300 5-Year $240 M 2, Year $170 M 1,700 Ultra 10-Year $170 M 1,700 Treasury Bond $120 M 1,200 Ultra Bond $120 M 1,200 Bilateral Pre-Execution Liquidity Sourcing via Committed Cross (C-Cross) C-Cross allows bilateral pre-execution discussions between counterparties prior to entering cross order into Globex, with no minimum quantity restrictions. Potential to complete 100% of the order between the two counterparties. Where order book participation at the cross price occurs, if certain price improvement conditions are met, original parties are still guaranteed 50% of the order. C-Cross Example 1. Client calls executing dealer, the two parties discuss terms of a trade (price and quantity) to be submitted via C-Cross 2. Dealer submits a single, two-sided C-Cross order to Globex, with both the buy and sell sides on the transaction second pre-cross window begins 4. If certain price improvement conditions are met upon entry of the order, at least 50% of the cross is guaranteed, with the remaining quantity then interacting with any applicable resting orders prior to crossing 6
7 CBOT-listed Invoice Spreads Methods Comparison CBOT-listed invoice spreads provide additional flexibility for trading and submission Exchange for Risk (EFR) CBOT-Listed Block CBOT-Listed Globex Committed Cross CBOT-Listed Globex CLOB Trade Types Outright Outright Calendar Rolls Tenor Switches Outright Calendar Rolls Tenor Switches Outright Calendar Rolls Tenor Switches Negotiation Bilateral Bilateral Bilateral pre-execution trade arrangement prior to cross order entry to Globex Anonymous, competitive execution in the central limit order book Credit Controls Managed directly by FCM Clearport RAV limits established by FCM Accounts will be registered and positively permissioned by FCM to trade Globex Invoice Spreads Leg Price Assignments Counterparties agree leg prices for swap and future Counterparties agree leg prices for swap and future Counterparties trade spread differential, CME Globex determines price for Treasury Future leg and related fixed rate for swap leg Submission Method Future: CME FEC Swap: Middleware to clearinghouse Submission of both legs to CME ClearPort for clearing Globex automatically sends both legs to CME clearing Settlements Treasury Futures leg settles to the daily settlement price for the applicable contract IRS settlements are determined using cleared IRS settlement curve 7
8 Example: CBOT-listed invoice spread Globex trade leg assignment and clearing Globex-Listed Invoice Swap 1 Transact as spread in bps 1 2-Year Invoice Spread Trade occurs at 19.6 bps 2 3 Treasury Future Price is assigned as last price Treasury Future Price is converted into a forward yield Treasury Future 2 Engine assigns futures price at last traded value (109 29) 3 Futures price is converted to on forward yield, relative to the CTD of the Treasury invoice Swap 4 Swap Engine assigns swap rate Invoice Spread % pts + Futures Fwd. Yield % pts = IRS Fixed Rate % pts 4 Add the futures yield + the transacted spread, which equal the IRS Fixed Rate that is booked Globex message reports invoice spread traded basis, and leg price for future FCM Futures Account In addition to fixed rate, all other swap terms enriched for clearing and available via STP Effective Date = Last Delivery Date Maturity Date = Maturity of CTD Security Reference Rate = USD 3M LIBOR OTC Swap Account 8
9 CME Contacts The latest information can always be found at For additional questions, please contact: Ted Carey Chicago Office Mark Rogerson London Office
10 Disclaimer Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of a contract s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. All references to options refer to options on futures. Swaps trading is not suitable for all investors, involves the risk of loss and should only be undertaken by investors who are ECPs within the meaning of section 1(a)12 of the Commodity Exchange Act. Swaps are a leveraged investment, and because only a percentage of a contract s value is required to trade, it is possible to lose more than the amount of money deposited for a swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. Any research views expressed are those of the individual author and do not necessarily represent the views of the CME Group or its affiliates. CME Group is a trademark of CME Group Inc. The Globe Logo, CME, Globex and Chicago Mercantile Exchange are trademarks of Chicago Mercantile Exchange Inc. CBOT and the Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago, Inc. NYMEX, New York Mercantile Exchange and ClearPort are registered trademarks of New York Mercantile Exchange, Inc. COMEX is a trademark of Commodity Exchange, Inc. KCBOT, KCBT and Kansas City Board of Trade are trademarks of The Board of Trade of Kansas City, Missouri, Inc. All other trademarks are the property of their respective owners. The information within this presentation has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for any errors or omissions. Additionally, all examples in this presentation are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. All matters pertaining to rules and specifications herein are made subject to and are superseded by official Exchange rules. Current rules should be consulted in all cases concerning contract specifications. Copyright 10
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