GCF Repo Index Futures: Lucky, Good or Both?
By Douglas Ashburn
“I would rather be lucky than good.”
-Baseball Hall of Famer Lefty Gomez
Although the above quote is widely attributed to Mr. Gomez, every trader I ever met has used the phrase at least once. I can honestly say I uttered those words at least once a week during my 20 years on the trading floor. Timing is everything, but in many cases, when assessing the success of a fortuitously-timed decision, it is difficult to separate the lucky from the good.
On July 16, NYSE Liffe U.S. launched its futures on the DTCC GCF Repo Index. By all appearances, the contracts are off to a promising start, with average daily volume of over 3,000 contracts. Open interest continues to climb each day, surpassing the 10,000 mark earlier this week. The open interest number is significant, as it may demonstrate market participants’ interest in using the index as an alternative hedging mechanism for interest rate risk.
What a coincidence. As the GCF contracts began trading, a rate-rigging scandal was erupting surrounding LIBOR, arguably the most widely used interest rate benchmark on the planet. The allegations initially focused on Barclays Bank but, according to documents filed by regulators in the U.S. and U.K., other member banks participated in similar misconduct, which involved submitting rates to LIBOR’s rate-setting agency that were inconsistent with rates actually offered in the market. In the wake of the scandal, many in the industry have called for a new interest rate benchmark to replace LIBOR. The launch of the GCF Repo Index futures could not have come at a better time.
“It’s just the right product at the right time,” said Tom Callahan in a recent interview with JLN. “The clouds around LIBOR, and with the dysfunction in the Fed Funds market, a lot of people are looking for a new short-term benchmark that is objective, that is, it’s not subjective rate set by a small group.”
So, was NYSE Liffe U.S. lucky, good, or both?
Regarding LIBOR, though, I would paraphrase Mark Twain and say that rumors of its death have been greatly exaggerated. Though the rate-setting mechanism has been taken to the woodshed and given a thorough beating, the rate itself is simply too embedded in the financial world to be dismissed. The rate-setting process will evolve into something modern, transparent, and incapable of being manipulated.
Here is a parallel from my own experience. For over a decade I had the dubious honor of chairing one of the forex option pit committees at the CME. One of the primary functions of the committee was to set, monitor, and approve end-of-day settlements. For many contracts, the settlement process was a daily lobbying exercise. Traders with large positions (and brokers representing customers with even larger positions), pleaded their case for a favorable settlement price. Some would “paint the board” near the end of the day with bids, offers and/or trades favorable to their positions. Since each options contract has hundreds of associated strike prices of varying expiration dates, with daily volume spread throughout, producing a fair settlement price that placated all parties was often more art than science.
Over time, certain market participants who claimed to be too often getting the short end of the stick, complained to the exchange. The exchange stepped in and began the process of formulaic, automated settlement procedures that use state-of-the-art modelling, combined with volume-weighted average price data from exchange contracts. Of course, the migration of trading from pit to screen has helped speed up the transition. It has taken years to implement and a hybrid of the old system is still in place in some contracts. But the point is, if the industry demands a solution to a problem, and the infrastructure exists that can support a solution, the system will evolve rather than die of irrelevance. My guess is that LIBOR will soon adopt a similar automated settlement.
Does this mean that the DTCC GCF Repo Index will not be useful? Absolutely not. One of the nice things about the index is that it uses price data from actual trades to compute the index. So, from a settlement standpoint, it is ahead of LIBOR.
Besides, how often have we seen the launch of a contract that was set to displace an existing product, only to witness a volume surge in both contracts. Options on the SPX were supposedly the death knell for options on S&P 500 futures. Ditto the VIX. Many of the popular ETFs have seen concurrent volume enhancements in related futures and options contracts. NYSE Liffe U.S. appears to have a winner on its hands, regardless of what happens with LIBOR.
That’s not lucky; that is just good.