TMX’s government bond futures market starts to shine

TMX’s government bond futures market starts to shine

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TMX Group is starting to reap the benefits of a multi-year strategy that has seen the Toronto-based exchange group develop a full suite of Canadian government bond futures contracts and make them available to the world through extended trading hours.

Montreal Exchange, the derivatives arm of TMX, has for years offered a deep and liquid market in the ten year Canadian government bond future and that continues to be case. But this year the five year government bond future has continued its recent strong growth trajectory with volumes up more than a third and volume in the two year bond future, which only launched two years ago, has exploded.

Simon Hughes, head of institutional sales at TMX, said: “The Canadian market has grown up in recent years and we now have the whole curve in place from the front end STIR (short-term interest rate) contracts all the way through to 30 years which we never had previously.”

Hughes is quick to reference Canada’s strong investment credentials – a mature, open market with world-class regulation supporting a solid, G7 economy – while admitting the exchange group’s fixed income market is benefitting from the fast-changing macro-economic environment.

“We are in a unique situation from an economic standpoint. In the past ten years since the Global
Financial Crisis, central banks were all racing to cut rates and even go negative, leaving little room to trade the front end of the curve, but we don’t have that problem anymore. Now, we’ve got diverging central bank policies, we have inflation spiking in certain parts of the world, we’ve got commodity countries, including Canada and Australia, doing exceptionally well. Opportunities abound.”

Hughes added: “We’ve also got divergence in currencies with the Japanese Yen hitting 150 to the dollar and the Pound nearing parity against the dollar so finally we are seeing a lot more alpha back in the market. We’re getting curve inversions in the bond markets and curves steepening elsewhere so there are huge opportunities now.

“Coupled with this, our launch of the two year was the last piece of the yield curve jigsaw and followed the successful five year launch around four years ago. We can safely say this has become a key contract for the Canadian market.”

He added: “Getting the five years off the ground took a lot of hard work as well as support from the Canadian banks. Mortgages are fixed off the five year part of the curve in Canada so it was always critical to make this contract a success. Once successful, it allowed us to develop curve strategies around 5, 10s, 30s and subsequently the 2 yrs.”

The two year Canadian government bond future (CGZ), which only launched in late 2020, traded in the 10 months to the end of October over 4 million lots, up an impressive 170% on last year.

The five year Canadian government bond future (CGF) traded in the year ‘til the end of October 7.5 million lots, an increase of 33.8% on last year, while volumes in the flagship ten year government bond future (CGB) were flat on last year at 27.7 million lots, according to the exchange.

The longer-dated 30 year Canadian government bond future (LGB) is less liquid but Hughes is equally optimistic about the prospect at the longer end following some recent technical changes to the contract spec.

“In terms of contracts, the 30 year should really come back strongly in January because we had to
tweak the contract due to the "wild card" option on the physical bond coupon.”

Hughes said trading in the March 2023 contract of the TMX 30 year government bond futures contract has resumed with the new spec which has reduced the delivery period to a single day.

Canada, like the US and the UK, is also moving away from Libor-based lending rates to so-called risk-free rates (RFRs). The Canadian RFR is the Canadian Overnight Repo Rate Average (CORRA).

For TMX, this means winding down its futures product that references Libor – the three month Canadian Bankers’ Acceptance (BAX) - and replacing it with a three month CORRA future.

Hughes said: “The BAX contracts this year have come off slightly because we are at an inflection point where CORRA is going to be taking over from the BAX contract. Having the two year has also helped at the margins, as some of the liquidity in the BAX contract has dried up.”

TMX’s BAX futures trading volume has fallen 37% this year on last year to 12.5 million lots in the ten months to the end of October while trading in the alternative CORRA futures has rocketed from a low base to 210,000 lots over the same period.

And these numbers should continue to rise from early next year as Canada holds on January 9 the first of two CORRA First days when its dealing banks will switch en masse to quoting swaps with CORRA rather than the old standard.

Hughes said: “CORRA is very much front-of-mind with us. January will see all the banks start to use CORRA for swaps and we transition to CORRA in June before a hard deadline next year so we should see the transition start in the next three to six months.

“We are starting to see it build already with CORRA’s open interest at 29,000 lots and growing. BAX open interest is currently around 750k contracts however so we should not forget there is a long way to go but once the swaps start that should be the trigger.”

Asked if the transition to CORRA presents any opportunities for TMX, Hughes added: “We may get some of the more focused European funds start to look at it whereas they haven’t looked at it before, thinking of Canada as the third market . Our job is to ensure that it is liquid, supported and it is widely known that it’s there.”

The growth of the TMX government bond futures business is partly due to increased international participation in the Canadian market made possible by TMX’s long trading hours spanning Asia and Europe. About 5% of TMX volume is outside of Canadian trading hours and about a fifth of volume within Canadian hours comes from outside of Canada, according to the exchange.

Hughes said: “We’ve got a Hong Kong Operation now with four or five people. Clients mainly trade there the SXF (S&P/TSX 60 Index Standard Futures) and the ten year contract with growing interest in the fives and twos out of Asia. At some stage we hope to launch CORRA contracts in Asian time zone.”

TMX extended its trading hours in two phases, to include Europe in 2018 and then to cover Asia in the middle of last year.

Hughes said: “The extension to include European hours was a great success and that opened us up at 7am London morning whereas the Asian hours now takes us to 20.5 hours. For example a fund based in Australia can start to trade later in the day in Australia and then follow the sun with their

“They still do the bulk of their trading when Canada is open but the liquidity is growing all the time. The ten year trades very actively but we are now seeing liquidity flow into the five and two years.”

Hughes has a particular interest in Australia as the former head of European capital markets for ANZ, a position he held for nearly five years before seven years as head of EMEA fixed income distribution at Canadian bank TD and joining TMX in 2019.

He said the extended trading hours combined with the maturing product set is also attracting a broader range of trading clients.

“We’ve had a lot of support from the liquidity providers, the prop shops and the banks but we are getting more and more asset managers, sovereign wealth funds and central banks. It’s really important to get a mixture of clients because you want the hedge funds and props to do the STIR contracts out to five years and you want the asset managers to trade the fives, tens and thirties while the sovereign wealth funds are a bit of mixed bag.”

With investors keen to avoid problems in other parts of the world by boosting their allocation to North America, Hughes wants funds to look again at Canada: “Anyone can trade the US. As a fund manager or hedge funds, you want to stand out from the crowd by making more alpha so I would say step away from the herd, there is the opportunity to make good money in Canada.”

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