Derrière la crique

Challanging the Dominence of Eurex Futures

(contains original spelling and punctuation)

“One of the key obstacles to the banks market making franchises profitability is the almost universal use by our customer base. This, of course, results in vital flow information being lost. Eurex bond futures have become both the primary pricing source and hedging tool of the dealer community. This has lead to a large decrease both bid-offer spread available on individual bonds and also a decrease in inter bond volatility. Additionally, at the same time as the volatility and bid-offer spread has decreased, as number of dealers has increased the liquidity available in individual bonds has increased dramatically. This has led to a potentially unstable situation were the liquidity being offered in the bonds is far greater than that offered in the bund future. We should be able to exploit this situation in a very profitable way by the following method.

1 Set up a system, which monitors the liquidity available in MTS (additionally we could use HDAT and SENAF). Initially take special note of the liquidity available within 2 cents of our mid-market in the 10 year sector and convert this into a bund future equivalent.

2  When there is a liquidity imbalance, by that I mean the liquidity offered say within 2 cents of mid in the 10 year is greater than that required to move the bund future by 10 cents, we drive up the future then hit out all the cash on MTS.We think there may be up to 20,000-30,000 bund equivalent of liquidity available within 2 cents of mid in the 10 year sector alone. Based on this the profits available on each of these trades may be in excess of USD 2.5mm. Aside from the profitability, continually doing these kinds of trades will have some potentially very beneficial side effects

1 Imposes a cost on our competitors for offering liquidity in MTS (inaddition to the costs they may be incurring quoting in Tradeweb).

2 It reduces the attractiveness of using the Bund future as a hedging tool.

3 Widens bid-offer spreads.

4 These trades will be visible to our competitors, so it may not be long before we see copycat trades. This will accelerate the process of decreased attractiveness of the bund and wider bid-offer spreads.

5 The only dealers who will be able to replicate these trades are those with very good access to MTS (primary dealers in most Euro zone markets). The ones, which will suffer, are the smaller primary dealers. So, over time, this may help to kill of some of the smaller dealers.

Overall, these trades may help to reduce the markets reliance on the Bund future and turn the European Government bond market into one that more closely resembles the US government bond market.”