1st July, 2020|Luke Jeffs
Cboe believes the European options market is failing to fulfil its potential due to insufficient transparent
Cboe Global Markets detailed on Wednesday its plan to revamp the ailing European options market with a new trading venue that will replicate in Europe the highly-effective US options market structure.
The US group said it will launch in the first half of next year an Amsterdam-based trading venue called Cboe European Derivatives that will initially offer futures and options on six Cboe European share indices.
The venue will be Cboe’s first European derivatives market and aims to offer European trading firms, including quant-based hedge funds, a European equivalent of the US options market, which is traded electronically on multiple competing exchanges including Cboe.
David Howson, the president of Cboe Europe, said his team has been working hard in recent months on various aspects of the project: developing the technology for the trading venue and its clearing house EuroCCP; engaging vendors to ensure clients can connect; preparing the regulatory applications for the exchange and clearing house; and talking to clients about the market’s structure.
Howson told Global Investor on Wednesday: “There has been active discussion about the market design. One of the key differentiators to this initiative is that the market design is going to be different which makes the marketplace interesting to new flow which we think will grow the European derivatives market.”
Howson feels the European options market is failing to fulfil its potential because the current markets are not sufficiently transparent, which is a turn-off for some hedge funds that are major traders of US options.
“We’ve been talking to all the various stakeholders from the market-makers to the sell-side to major index and systematic hedge funds that are the potential source of this additional flow.
"We see the opportunity to offer an open, lit and vibrant order book that can be analysed and interacted with to bring better spreads and more flow to Europe,” he said.
Howson continued: “If you talk to a systematic or index hedge fund about the European market, they see a few frictions such as the lack of transparency, which prevents them from interacting with and assessing the market in a meaningful way. One of the pillars of the value proposition is a market structure which encourages onscreen liquidity.”
Cboe believes the current European options markets lack transparency partly because Mifid II reporting rules exempt orders over a certain size from real-time reporting. Howson said the European market is characterised by block-matching, also known as the “call-around” market, where orders are agreed off exchange and then only input on to the exchange as blocks.
He said: “Because of the transparency rules with Mifid, these trades are not published until the end of the day so it’s very hard to understand what’s going on, which means the spreads and the depths of books are less attractive then they could be.”
The Cboe Europe president said he and his team are still in talks with various market participants about the specifics of the market structure but this will be agreed in a matter of weeks to enable a prompt application to the Dutch regulator for the necessary licence to start trading derivatives.
Howson said: “We have to get the rule books, the participant manuals and the associated documentation approved and we are planning to submit them to the AFM in July, and let participants have a first look at the draft rule books for the venue.”
The Cboe president said it is vital Cboe European Derivatives finds the right proposition to attract the quant funds as they could provide much-needed additional liquidity in European options.
“For the systematic hedge funds, through the ability to trade in one place six benchmarks from day one with the right-sized contracts, with the appropriate tick sizes in a lit market order book with a single margin pool, the frictional cost of trading is much lower,” Howson said.
For Ade Cordell, the newly appointed president of Cboe NL, the group’s Amsterdam-based arm, the relative size of the US and European markets speaks volumes.
“Why is the US market five to seven times larger than the European market for options? Why is the options market in Europe trending down whereas the options market in the US over the past ten years is trending up?”
Cordell said a cross-section of participants, including the quants, is needed to build a viable market and Cboe is having these conversations.
“We have spoken to the sell-side institutions, we are speaking to quant funds, particularly the European arms of the US funds, we are speaking to proprietary traders in Europe and we are speaking to market-makers and retail brokers, so those firms that offer futures and options products to their retail clients,” he said.
The European retail market is easily overlooked, according to Cordell, but it is meaningful in the US and he feels there is untapped potential in Europe also.
“The US market has this strong retail market participation but there isn’t a lot of that in Europe. It would be remiss of us not to tap into that as well. Given we are speaking to all of those different client types, we would like to see representation from them all albeit they will come on stream in different schedules.”
The exchange group said it will launch Cboe European Derivatives in the first half of 2021 while Cordell said the exact date will be determined partly by clients.
He said: “We will go live when we have a core set of participants ready. The pandemic may have effect on participants’ readiness but we want a core set of participants to coalesce around the platform on day one. We want to see volumes print, we want to make sure the technology works front-to-back and we want to see a gradual uptick in volumes from there on.”