Introducing Single Treasury Futures

Today we introduce readers to a new product – Single Treasury Futures (STFs) – developed by BNY Mellon and NASDAQ OMX. STFs are a secured funding product that will trade on NASDAQ Futures, Inc. (NQF) and clear on the OCC. It’s an interesting idea for asset owners to finance single name positions and for cash providers to capture synthetic term repo financing rates.

As the name implies, a STF is a contract on a specific security. NASDAQ OMX is able to issue STF contracts on existing Cusip Treasury Bills, Notes and Bonds by issuing multiple contract expirations following each new benchmark Treasury auction. Settlement at the end of a contract will be realized by delivery of the specific CUSIP. Unlike existing Treasury futures contracts, there are no “cheapest to deliver” issues; this allows hedging with no basis risk. Trading is anticipated to start around Q3 2014, pending filing.

Conceptually, the STF is a forward settling US Treasury trade. The forward price takes into account the current price plus the cost of financing. In a world where coupon accrual is greater than financing costs, the forward costs will likely be, all else equal, lower than the spot value of the bond. Where the financing rates are negative, reflecting a very tight repo market, the futures price will reflect that scarcity.

Here’s the math:

STF Price = Treasury Px – (Accrued Interest to Expiry – (Invoice price*IRR*d/360))
As a practical example on the 5 year Treasury held for 45 days:

5yr STF Price = 100 – (.168139 (accrued interest) – .00875 (Repo interest))
5yr STF = 99.8406

This translates into 7 bps in term financing over the 45 day period.

A major feature of the product will be an Exchange for Physical (EFP) market. Executing brokers will offer a “basis” trades consisting of the underlying package of cash + futures trades. Like outright STF trades, the futures side will be routed to the OCC for clearing; cash trades will go through FICC.

The margining process on STFs will be identical to other futures contracts. Contract size will be $1,000,000 with price quotes using US Treasury markets conventions. Minimum price change will be ¼ of a 1/32nd at the short end of the Treasury curve increasing to a 32nd of a point further out the maturity spectrum. EFP markets will be quoted using price, size, and implied repo rate.

If all this seems familiar, look no further than Single Stock Futures (SSFs) for the inspiration. According to OneChicago, the now-fast growing US SSF marketplace, single stock futures “…are a tool used to improve financing of equity positions…” STF have the same intent for US Treasury positions and like SSFs, financing rates will be a major driver of pricing. More details on Single Stock Futures can be found in the May 2013 Finadium report, “Single Stock Futures, Prime Brokerage and Securities Lending.”

There are important differences between the equity and Treasury versions of the product however: while SSFs may be thinly or actively traded, there is already a robust financing market for US Treasury securities. The new value that STFs add is to facilitate price discovery and to make the entire transaction centrally cleared. STFs aren’t the first US Treasury derivative to ply this road, but the single CUSIP financing nature of the product is a new twist and one that solves some problems with existing products.

While the prices reflected in the futures prices are likely to allow for some arbitrage profits between the cash and repo markets, we anticipate that the STF product will help increase market liquidity overall. Possible incentives to attract participants to the product include market advantageous regulatory treatment, lower margins, and balance sheet relief. We will explore these in later posts.

This article was sponsored by NASDAQ OMX.

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4 Comments. Leave new

  • Barry Stutner
    March 26, 2014 12:23 am

    Interesting concept. I am not sure how this product deals with the ‘short squeeze’ or does it make the problem worse?

    An investor goes short a specific Cusip and needs to deliver that Cusip?

    Reply
  • We asked the STF product people about Barry’s question. Their response was:

    No short squeezes are possible, because unlike the CME there is no obligation to deliver the underlying security.
    · This mitigates any potential for price manipulation through delivery
    · This eliminates any exchange penalties for fails
    · OCC only clears the Futures position and reports the net long/shorts to its members
    · At expiration OCC calculates a single net receive and deliver position by member for input into the FICC net
    · Settlement occurs at FICC the next business day
    · FICC’s cash market conventions deal with fails as they do today

    The contract was designed to settle seamlessly through FICC to avoid price manipulation and collateral squeezes.

    Reply
  • Barry Stutner
    March 26, 2014 1:47 pm

    Very innovative product! Hedging a cash Treasury portfolio with futures is fraught with danger because of the cheapest-to-deliver risk.

    This product addresses both that issue and the squeeze risk.

    This product fills an obvious market need!

    Reply

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