Clients eye EUREX/LCH amid seasonal flows
The seasonal return of new issuance and its associated hedging through interest rate swaps presents an opportunity for end-users to access increased market liquidity. But when it comes to gaining access to the EUREX/LCH basis market, clients say you have to act quickly.
“The basis tends to be very illiquid,” reports one end-user, “We know these big new issues are coming from the likes of KfW and other borrowers, so you’d expect to see some movement on the screens. But that’s not really the case and quite often it’s remarkably calm.”
Over the past couple of weeks during new issuance the 5y EUREX/LCH basis mid has been indicated between 0.96bp and 1.06bp (versus a range of 0.7-1.55bp YTD) and 10y EUREX/LCH basis between 2.9bp and 3.2bp (vs 2.25-4.05bp YTD).
One possible explanation for the lack of movement is that dealers are warehousing the risk themselves. However, one trader at a European bank felt that risk appetite for EUREX/LCH basis has diminished and is yet to fully recover. “Last year there was a big decoupling across the EUREX/LCH curve. It was something that we hadn’t really seen before and made dealers more cautious when hedging the basis,” he says.
To recap, during Q4 2022 there was a significant divergence between 10y (widening) and 30y (tightening), “Previously, a dealer needing to hedge a 30y exposure might do something in 10y if that’s where the liquidity happened to be. But since last year’s decoupling it seems people have stayed a bit wary.”
Rather than banks warehousing the risk, sources tend to agree that dealers are sourcing the other side of the EUREX/LCH basis off-market. In the case of new issue-related flows, this means working ahead and procuring the other side before a bond deal prices.
One seasoned dealer was quick to point out this is a longstanding practice when it comes to basis markets. “It’s the same with 3s6s, cross-currency basis and 3s/€STR. It’s your go-to method in September time.”
Still, some end users say that by the time new issues hit the screen, another client has likely been lined up to take the other side, “If you are wanting to trade the EUREX/LCH basis then you look at who is pricing the new issue on the day and can go to them and say you can take some of the risk for them. But it’s not always that simple and by that stage it’s often too late.”
As a result, for clients wanting to see attractive EUREX/LCH prices (that are closer to mid) it’s a case of having good communication with dealers and a readiness to execute quickly, “The most important thing is that the dealers know you are able to trade. Then if they do come to you with a price you must act quickly. It might not be on the day you want or the exact tenor you want, but if a good opportunity presents itself then don’t hesitate.”
On a positive note, market participants say conditions have improved since the volatility at the end of last year. “There was definitely some political risk that seemed to push everyone to one-side,” said a trader.
In early December 2022 the European Commission published a proposed amendment to EMIR known as the ‘Active Account Requirement’ whereby institutions could be forced to clear a minimum amount of euro-denominated derivatives at a European CCP.
Subsequently, several industry groups including buy-side associations warned about the costs to end users. In its response to the EC proposal, the ECB said any new requirements should be implemented gradually. "That political risk has since moved to the background and now it's become more a pricing choice again," a trader said.