The needs of buy-side firms are rapidly changing in the post-crisis and regulatory-driven environment, sparking a wave of new product innovation in the derivatives market. In the second part of theTRADEnews.com’s focus on new products, we look at Europe’s evolving dividend futures offerings.
Dividend futures have been gradually rising in popularity among the buy-side since the financial crisis, gaining pace rapidly on their OTC equivalents.
Eurex launched the first set of exchange-traded dividend contracts back in 2008, before releasing single-stock offerings in 2010. Similar products are also offered in Europe on NYSE Liffe and Borsa Italiana.
Initially, the products were being used mainly by banks’ prop desks, private banks and hedge funds, before a limited but growing number asset management companies adopted them too. The contracts are attractive to large players looking to mitigate exposures to individual companies.
“In a nutshell, today, the dividend futures market offers all the characteristics a young and growing market should have in order to attract buy side investors,” said Erwan Tigreat, business development manager at dividend futures specialist hedge fund Melanion Capital.
“Index dividend futures are attractive to large players as they can be used to add on, or mitigate, important exposure very quickly. Single-stock dividend futures appeal to different players with specific exposure to individual companies. As such they have helped broaden the spectrum of participants in this market.”
Investors hoping to hedge their exposure to major US stocks through dividend futures have been thwarted by the fact that the Securities and Exchanges Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have not agreed which regulator should oversee the products. With US exchanges stymied, Eurex became the world’s first exchange to offer US single stock dividend futures, listing contracts on 21 blue-chip stocks.
Volumes are still modest, but could be set to rise with the entrance of new players into the asset class. According to Chris Brocklehurst, head of delta one trading, Europe at Barclays, some buy-side firms are waiting for liquidity to build up. “A lot more clients have moved from dividend swaps to futures,” he says. “But the big institutional investors haven’t really got involved yet and the first bank to crack that will be onto a winner. At the moment, it is the chicken and egg scenario.”
Dividend swaps were launched in the early 2000s and according to Tigreat, firms are turning to futures due to a number of embedded constraints in the OTC products.
“Counterparties had to have bilateral ISDA agreements in place before they could trade together – a hassle at best for bigger players, a barrier to entry even, to smaller market participants,” he continued. “And once a market participant cleared that hurdle and was able to trade div swap, each trade entailed counterparty risk. Finally, as often in OTC markets, there was a lack of transparency. The first dividend future listing gave market participants an instrument with no counterparty risk, no need for ISDA approval, and market transparency. It was bound to succeed.”