A shadow of disruptive events hangs over the stock markets in 2019.
Gianluca Minieri, CEO of Amundi Intermediation UK & Ireland, explains the skills and tools that a buy-side trading desk needs to handle these risks, and Tim McCourt, Global Head of Equity Index and Alternative Investment Products at CME Group highlights the value of derivatives when handling event risk in the year ahead.
Dan Barnes Welcome to Trader TV Equities – your insight into the trading climate for professional stock investors. I’m Dan Barnes. Event risk could be massive for any portfolio in 2019. In December’s show we’re talking with Gianluca Minieri, CEO of a Amundi Intermediation for UK & Ireland, and Tim McCourt, Global Head of Equity Index and Alternative Investment Products at CME Group, about the skills and tools that trading desks need to handle event risk in the stock markets. Gianluca, welcome back to Trader TV.
Gianluca Minieri Thank you, Dan. It is nice to be back.
Dan Barnes So in 2019, there are a number of big events which could potentially impact a portfolio. How are those events, and the risks associated with them, manifested on the trading desk?
Gianluca Minieri When we ask if there’s any event that is going to create risk for us in 2019, we are really asking, to what extent this event will have an impact in terms of liquidity and how are we going to manage them?
Dan Barnes And when we talk about liquidity, often people talk about liquidity in the fixed income markets. How do you see that balancing out between equities and bonds?
Gianluca Minieri The traditional reclassification of liquidity between equity and bonds is not relevant anymore. I mean, if we look at liquidity, the equity markets are doing fine. I think in 2018 on the global scale, we have seen a reduction of the number of orders. But funnily enough, the reduction has been experienced more in the US where we didn’t have the affect of any bank regulation, while in Europe the liquidity and equity market is actually improved in 2018. The liquidity in fixed income market is also at a quite good, reasonable level, although maybe in European corporate bond market, trading in a meaningful size can still be challenging. We think that a good classification in order to understand how liquidity is distributed across the asset classes, is the difference between developed and emerging. In developed markets liquidity is doing fine. Emerging markets, the frontier markets are a different story. The perception is that the liquidity resilience is very weak. And in case of the fast market, the turbulence in the market, we feel that liquidity might be a challenge.
Dan Barnes How might you use non-cash instruments to manage event risk of the sort we’re going to see next year? And how does that affect the risk profile of the portfolio?
Gianluca Minieri Today the use of non-cash instruments is stimulated by the liquidity or the lack of it. Because readjusting and rebalancing a portfolio is very costly. If they have to be done using your cash, using your holdings you have in your portfolio. So especially if this type of rebalancing are not strategic, but maybe a little bit more tactical than strategic, then the portfolio manager is much more keen to use derivatives, because they are quick, they are liquid, and they can be more effective in terms of taking a view on a specific risk or if it’s an interest rate portfolio. And last but not least, I think that derivatives are also much more used today for the typical use that they’re were actually made for; to hedge specific risk in their portfolio. Very often portfolio managers see these as a very cheap way of optimizing their portfolio, but this is because they do not see a lot of other costs that might be involved when trading a derivative. I would mention the clearing cost, but also the necessity of exchanging collateral, having a collateral management team, the reconciliation team. So, from a company perspective, as a CEO of a company, I would look at derivatives in a much more strategic way. So you need to ensure that when all costs are added up, it still makes sense to use the derivatives instead of cash instruments.
Dan Barnes If you look at the predictions of market activity for 2019; we’re seeing predictions of volatility and there are certain known events. How would you characterize the effect that this might have on trading for a buy-side firm?
Gianluca Minieri Investors are asking their investment managers to be able to navigate safely through this challenging environment. In a market environment where investment opportunities are scarce, in a market environment where carry trades are shrinking, I think we need to start looking at volatility as a source of alpha, rather than just as a risk to hedge. I think in 2019, investment managers will concentrate more on generating, creating those types of market neutral strategies that can generate returns in a flat market, while maybe at the same time hedging from extreme risk. So, the type of overtly, strategicly, being a professional seller of volatility could probably be a successful strategy in 2019.
Dan Barnes Gianluca, thank you very much for your time.
Gianluca Minieri Thank you very much, Dan.
Dan Barnes Now I’m going to speak with Tim McCourt, Global Head of Equity Index and Alternative Investment Products at CME Group, about the potential to use derivatives to better manage event risk in 2019’s equity markets. Tim, welcome to Trader TV.
Tim McCourt Great, thanks for having me. Glad to be here.
Dan Barnes Can you tell us, how might event risk effect activity in the derivatives market over the coming year?
Tim McCourt Well, I think it’s hard to forecast the exact impact of any one specific event or series of events in the market. But if we look at 2018 where we saw the return of volatility to the global equity markets, we can be certain that this is going to continue into 2019 in some form or fashion. When looking at how these events may impact a customer’s investment or trading decision, I think it’s important to note that these events are no longer comporting to a standard Monday-through-Friday, 9-to-5 news cycle. We’re really seeing market moving events happen all throughout the day, all throughout the evening. This is a benefit that CME provides by providing near 24-hour access to our futures and options on futures market, such that when these market moves occur, customers can turn to CME to manage their risk or to implement the trading strategies they’ve decided with respect to their global equity index exposure.
Dan Barnes How do you see the use of non-cash instruments changing amongst buy-side firms?
Tim McCourt I think what’s interesting when we’re looking at buy-side firms and their use of non-cash instruments, such as futures or options and futures available here at CME, their use case has evolved over time. Typically or traditionally, the buy-side has used futures as a way to access their global equity index exposure, from a portfolio replication perspective or implementing beta or looking at equitizing in their portfolio. But with some of the products brought to market at CME, we’re looking to evolve that transactional handshake that the buy-side customer uses, such that they could more precisely manage their global equity index exposure. Some of those things that we’ve seen the adoption of from the buy-side are things such as BTIC or Basis Trade Index at Close, or TACO, Trade at Cash Open, which allow market participants to trade futures in the basis form against the equity index they’re benchmarked to. Those are things that we’ve seen market participants use in terms of managing their risk, as well as the continued use of using the liquidity and the robustness of CME Group equity index futures, in managing their core equity index exposure across the globe.
Dan Barnes And what are the advantages of using listed derivatives over the counter derivatives?
Tim McCourt What’s interesting is over the past few years we’ve seen customers, across the various market segments look to and turn to listed derivatives in lieu of OTC products, because of the capital efficiencies afforded by essentially cleared futures and options on futures at CME. Fx if we look at just some of the US equity index exposure and the impact of uncleared margin rules, there has been an undoubted tailwind to futures, specifically our total return futures that we’ve introduced at CME in this regard. The margin efficiencies and the capital efficiencies that futures provide, are far superior to what’s available in the OTC market or what market participants may be subjected to, as a result of some of the things, such as uncleared margin rules, which introduces a 15%, initial margin requirement on uncleared equity index swaps, or some of the Basel-related, line item charges, such as on options portfolio, or RWA charges that are being passed on to market participants, because of the capital required being set aside. So, when we look at centrally cleared products such as futures, or options and futures at CME, these are a great way for clients to either directly or indirectly access the benefits, because they are trading directly at the exchange. By quoting products that are essentially cleared at CME through their dealers, they will enjoy some of the savings that the dealers have as well, in terms of the price being quoted to them by being more efficient at CME through options on futures, and futures.
Dan Barnes And how would you characterize the impact that employing futures and options can have upon the trading and investment process overall?
Tim McCourt When looking at the impact that using futures or options on futures could have on one’s portfolio, or the impact on investing, I think it’s important to keep in mind things such as capital efficiencies or margin efficiencies, that can be afforded to a participant by trading and managing their global equity index exposure at one exchange and one clearing house here at CME. But when we look at the ability to deploy more tactical strategies, I think one of the advantages that futures and options on futures afford customers beyond the capital savings, is the ability to be more precise with their risk management when they need it. When we look at some of these global equity trends that are happening in 2018, and expected to continue 2019, customers may need to more precisely manage their risk or they may want to deploy certain things, whether it be sector-rotation or how they equitize their portfolio, or simply how they manage their cash to operate their funds and their strategy. These are benefits that futures can provide by tapping into the near 24-hour liquidity at CME, as well as the low, total cost in terms of implementing their global equity index strategies through futures and options on futures at CME. These are just some of the impacts. And it’s something where we’ve seen continued increase of activity across all customer segments in 2018, and with continued product innovation at CME, such as BTIC (Basis Traded Index at Close), or total return futures, we’re only increasing the opportunity for customers to use more capital-efficient tools at CME Group, when managing their global equity index exposure.
Dan Barnes That’s great, Tim. Thank you very much.
Tim McCourt My pleasure.
Dan Barnes I’d like to thank Gianluca Minieri of Amundi Intermediation, and Tim McCourt of CME Group, for their insights into equity markets in 2019, and of course, you for watching. To catch our monthly reports on other markets or to subscribe to our newsletter go to TraderTV.NET.
