LONDON: With European sovereign risk dominating global markets, French government bond futures are set to make a comeback next month. The contracts, referencing Obligations Assimilables du Tresor with maturities of 8.5 to 10.5 years, are set to begin trading over the Eurex derivatives exchange on April 16.
The launch adds to the bourse's existing offering of eurozone government bond futures that includes German Bund contracts through to 35 years duration, as well as medium and long-term contracts on Italian BTPs.
For many investors, the growth of a liquid sovereign credit default swap market has reduced the need for more alternative hedging tools - hence the limited attempts to re-launch products that effectively became obsolete when Germany Bunds became the eurozone debt proxy.
But for investors unable to hold CDS contracts, listed futures offer a useful alternative, particularly given the success some hedge funds have had taking short positions on French government bonds through the CDS market.
"It is a useful tool for people who like to have more flexibility in their hedging options," said Ciaran O'Flynn, co-head of European government bond trading at Morgan Stanley, which will act as a market-maker in the new contracts. "There is demand in all markets for multiple instruments to trade as this creates arbitrage opportunities, which can enhance liquidity in all versions of the market."
The contracts represent a leveraged platform in which to express views and as a tool for OAT basis trading, while ongoing concerns over the suitability of German debt as a proxy for the region could see liquidity shift to French products.
"The French government bond is actually less volatile in yield terms than most others and it could be argued that it's one of the best proxies for euro government bond markets these days," said O'Flynn.
But success will largely depend on dealer participation. "We think the new contract will be a welcome addition to the Eurex bond futures family. However, it will need a strong dealer support network to support liquidity," said RBS derivatives strategist Brian Mangwiro in a report.
EUROZONE DIVERGENCE
The new French contracts represent the first such instruments to launch since Eurex reintroduced Italian BTP futures in 2009 amid speculation that early signs of eurozone divergence would intensify.
That has certainly been the case, and while the earlier trend saw core eurozone members such asGermanyandFrancediverge from peripheral issuers such asGreeceandItaly, divergence within the core group has escalated. Five-year CDS on theFrenchRepubliccurrently trades at 150bp - more than double the 65bp spread forGermany. That differential was just 30bp a year ago.
Further government bond futures markets could be of interest to investors, though liquidity will be the main determining factor for future launches.
"It would be useful to have a futures market operational for all eurozone sovereign bond markets, but realistically some markets are just not big enough or active enough to justify it," said O'Flynn.
"A future can bring more liquidity to a market by creating a vehicle for basis traders and other relative value traders who otherwise would not be involved. This promotes liquidity and likely therefore efficiency, which at the margin tends to suppress volatility and hence lower the liquidity discount embedded in underlying bond valuations."
Interest in Italian BTP futures has increased alongside spread divergence. Since their 2009 launch, more than 5m contracts have changed hands for average daily volume of 9,287 through 2011.
Open interest in the June expiry for long-dated maturities (8.5-11 years) is currently 28,707 and a total of 40,000 across the three separate contracts. However, volumes remain small compared to Bund futures, which have open interest of over 800,000 in the June expiry for 8.5-10 year maturities.
The French contracts will be similar in structure to Bund futures to enable efficient hedging as well as spread trading between the three eurozone products on 10-year government bonds.
"With the introduction of this new contract we are responding to the great interest shown among market participants in more customised hedging solutions," said Mehtap Dinc, head of product development at Eurex. "Moreover, the market for French government bonds is likely to benefit from the extended opportunities in basis and repo trading."
Copyright Reuters, 2012
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