STOCK INDEXES Unde ersta andin ng Equity EFRP Ps SEPTEMBER 3, 2013 John W. Labuszewski Managing Director Research & Product Development 312-466-7469 jlab@cmegroup.com Lori Aldinger Manager Research & Product Developmentt 312-930-2337 Lori.aldinger@cmegroup.com
1 To learn more about EFRPs, please consult our EFRP Advisory Notice found at the following URL - http://www.cmegroup.com/clearing/trading- practices/efp-efr-eoo-trades.html Exchange for Physical (EFPs) transactions originated offsetting cash or spot market position. An EFR over a century ago in grain and other physical represents an exchange of a futures position for a commodity markets. Over the years, the practice has been adopted in the context of financial futures comparable OTC swap or similar instrument. Finally, an EOO represents an exchange of an Exchange and generalized as Exchange of Futures for Related option position for a comparable OTC option Positions (EFRPs). This document is intended to position. explain EFRPs as they are currently practiced in CME Group stock index futures markets. 1 EFRPs may be thought of as privately negotiated basis trades. The futures trade is bilaterally Ex-Pit Transactions negotiated apart from a competitive trading environment such as the CME Globex electronic The term ex-pit transaction is generally applied to tradingg platform, or the Exchange floor, and any transaction that is executed on a non- subsequently novated to the CME Clearing House. competitive basis. Once accepted by EFPs, EFRs and EOOs EFRP Transaction CME Clearing House, represent types of the position is Party A Bilaterally negotiated Party B EFRPs (see CME and Buys Cash cash transaction Sellss Cash accounted for just CBOT Rules 538), Product Product like any other futures which in turn position. Apart from Long cash/ Shortt cash/ represent a subset of short futures long futures the offsetting a larger group of ex- instrument against Bilaterally negotiated Party B which the Exchange Party A pit transactions Sells Buys including block trades ex-pit futures trade Futures Futures futures or option (see CME and CBOT Futures trade contract is paired, Rules 526); and, submitted to CH these various forms back-office transfers of EFRPs are (see CME and CBOT CME Group executed and Rules 853). Clearing administered in House essentially an A block trade is an identical fashion. ex-pit or privately negotiated futures transaction which, unlike an EFRP, does not involve an offsetting CME Group plays no role in facilitating the execution cash or OTC transaction. While there are some of, orr subsequent book-keeping for the cash regulatory distinctions, all these trades represent non-competitively negotiated transactions which are referred to in the aggregate as ex-pit transactions. position. Rather, the performance of these functions is incumbent upon the counterparties to the EFP transaction. What is an EFRP? An EFRP is a transaction that is privately negotiated between two counterparties and involves the simultaneouss exchange of a futures position for an economically offsetting cash, spot or OTC position. An EFP is a type of EFRP that contemplates the exchange of a futures position for a comparable Offsetting Position The cash, spot or OTC position that is traded opposite to the futures contractt in the context of an EFRP must be a product that represents a legitimate economic offset. The Exchange identifies acceptable offsets for any particular listed market in an FAQ published by the CME Group Market Regulation 2 CME Group strivess to balance the needs of firms that provide liquidity in the central limit order book (CLOB), on the CME Globex electronic trading platform, with the needs of institutions, maintaining a liquid, orderly and transparent marketplace under a wide variety of market conditions. 1 Understanding Equity EFRPs September 3, 2013 CME GROUP
Department. In the context of stock index futures, recognized offsetting positions include (i) baskets of stock; (ii) Exchange Traded Funds (ETFs); or, (iii) OTC equity swaps. Stock baskets must be highly correlated to the underlying index with a correlation of 0.90 or greater to be part of an EFP. Further, these stock baskets must represent at least 50% of the underlying index by weight; or, include at least 50% of the names of the underlying index. The notional value of the basket must be functionally equivalent to the value of the futures component of the trade. Exchange Traded Funds ("ETFs") are also acceptable as part of an EFP provided that they mirror stock index futures traded on the Exchange. For example, SPDRs represent an acceptable mirror for S&P 500 futures insofar as the SPDR Trust holds the stocks that constitute the Index in a (near) exact match. Likewise, QQQQs represent an acceptable mirror for Nasdaq-100 futures. Equity swaps that mirror stock index futures are likewise acceptable as a component of an EFRP transaction. How to Transact? An EFRP may be transacted at any time and at any price agreed upon by the two counterparties. Two customers may transact an EFRP amongst themselves provided that the resulting futures position is subsequently submitted to the CME Group Clearing House through the facilities of a Clearing Member. More commonly, however, a customer establishes a relationship with a dealer who is inclined to make a market, i.e., show a bid and an offer, in the particular market(s) in question. These dealers will normally require that the customer carries a futures account as well as a securities account in which the resulting futures and cash positions may reside. Clearing House through a Clearing Member via the Exchange front-end clearing (FEC) systems, by calling the CME Facilitation Desk, or reported directly by the trader or designated broker via CME ClearPort. Note that block trades may likewise be reported electronically to CME Clearing via CME ClearPort. One must be registered in CME ClearPort as a broker to enter trades, or as a trader if you are the designated party to a trade. The CME ClearPort demo provides an introduction for registering and submitting ex pit transactions. 3 The cash position resulting from an EFRP continues to be held in appropriate accounts established by the EFP counterparties and is not reported to the Exchange upon execution. If called upon during the course of a periodic audit, however, Clearing Members may be required to produce statements that evidence that the offsetting position was transacted and meets Exchange standards as a valid offsetting position. While dealers often show bids and offers on EFRPs to customers directly, the Exchange does not post such quotes or otherwise facilitate the execution of these transactions. However, CME Group has implemented a registration process in order to provide firms with market maker contact information for the purpose of engaging in block trades for options and futures. 4 Who Trades EFPs and Why? EFRPs are generally utilized by institutional traders who find themselves with existing cash positions which they may wish to offset using futures transactions. For example, a market maker in ETFs may find themselves either long or short large inventories which they may wish to hedge. By utilizing an EFRP transaction, these market makers may readily transform a pre-existing ETF position into a futures position, thereby enjoying the liquidity and financial sureties associated with There are a variety of firms which may make markets in EFRPs although the Exchange assumes a neutral posture and does not offer recommendations in this regard. After two counterparties consummate an EFRP transaction, the futures position is reported to the 3 Please refer to the following URL - http://progressive.powerstream.net/008/00102/edu/inte ractive/clearport/demo/start.htm 4 Please refer to the following URL - http://www.cmegroup.com/education/events/forms/rfqfollowup-registration.html 2 Understanding Equity EFRPs September 3, 2013 CME GROUP
trading at CME Group. So-called program traders who seek to arbitrage possible temporary pricing discrepancies between cash and futures markets may find EFRPs to be a convenient way to liquidate or reduce possible long or short stock basket holdings. Value of Transparent Pricing Ex-pit transactions including EFRPs are allowed by CME Group as an accommodation to traders who find this a convenient and expeditious way of conducting business. They are not intended to represent the mainstream way of trading futures. Rather, the Exchange expects that the plurality of trading shall be conducted in an open, competitive trading venue such as open outcry or on GLOBEX. Price discovery represents a primary function of the futures market. Thus, it is important to promote a transparent trading venue as the primary trading venue where values may readily be referenced. Liquidity is a necessary prerequisite for the efficient discovery of equilibrium prices. It is not our intention to divert any significant volume of trade from the mainstream competitive marketplace. In fact, only a small proportion of volume in major stock index futures generally is transacted as EFRPs as indicated in the accompanying table. We do note the rather high proportion of EFRPs in the context of the standard S&P 500 and Nasdaq- 100 contracts. This may be attributed to the fact that these contracts are sized at 5x the value of their E-mini cousins. As such, they are clearly designed to serve the needs of significant institutional customers transacting in quantity and more inclined to manage their risk exposures with the use of EFRPs. Further note that volumes in the standard sized contracts have generally declined as E-minis have become increasingly popular. As such, the proportion of EFRPs in S&P 500 and Nasdaq-100 futures in total still represent a very small proportion of the total trade. Still, EFRPs represent a useful and convenient outlet for some traders and, therefore, remain consistent with the Exchange s mission of providing customers with an efficient source of price discovery as well as hedging utility. To learn more about CME Group stock index futures, please visit our website www.cmegroup.com/equity. Proportion of EFRPs to Total Volume (January 2013 June 2013) Volume EFRPs % E-Mini S&P 500 246,523,499 587,003 0.24% S&P 500 2,342,147 485,740 20.74% E-Mini Nasdaq-100 29,883,963 23,062 0.08% Nasdaq-100 132,784 77,313 58.22% Mini $5 DJIA 18,729,931 0 0.00% E-mini S&P MidCap 3,027,528 8,574 0.28% 3 Understanding Equity EFRPs September 3, 2013 CME GROUP
Copyright 2013 CME Group All Rights Reserved. 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 examples in this brochure are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. CME Group is a trademark of CME Group Inc. The Globe logo, E-mini, Globex, CME and Chicago Mercantile Exchange are trademarks of Chicago Mercantile Exchange Inc. Chicago Board of Trade is a trademark of the Board of Trade of the City of Chicago, Inc. NYMEX is a trademark of the New York Mercantile Exchange, Inc. All other trademarks are the property of their respective owners. References to CME Clearing are to CME s U.S. Clearinghouse. S&P, S&P 500 and Select Sector indices are trademarks of S&P/Dow Jones Indices LLC ( S&P ) and its affiliates (including Standard & Poor s Financial Services LLC)and have been licensed for use by Chicago Mercantile Exchange Inc. The information within this document has been compiled by CME Group for general purposes only and has not taken into account the specific situations of any recipients of the information. CME Group assumes no responsibility for any errors or omissions. All matters pertaining to rules and specifications herein are made subject to and are superseded by official CME, CBOT and NYMEX rules. Current CME, CBOT and NYMEX rules should be consulted in all cases before taking any action. 4 Understanding Equity EFRPs September 3, 2013 CME GROUP