The Real Solution to Interest Rate Futures: Research by Next Level Derivatives, Bart Chilton, and OTC Partners

Why people are excited over this innovation.

Next Level Derivative’s unique design allows complex trading to be done in a simple and straightforward format where the risk is known and transparent.  This innovation provides solutions for regulators, central banks, liquidity providers, large banks, and end users.  It can be distributed on current stock exchanges; existing futures architecture or even SEF/ OTC formats without requiring additional systems or infrastructure costs.   It remedies limitations of the existing product set.

The timing of this innovation is timely given the stated objective of our Federal Reserve to “finding an alternative to LIBOR.”  All of the stated STIR alternatives (Repo, FED Funds, Treasury rates) lead to the need for trading Forwards on Treasuries in a more efficient format.  It is highly probable that the market will once again shift back to utilizing the Treasury Options Market, away from the OTC LIBOR based “Swaption” Market, as it did following the Lehman Brothers Bankruptcy.

Regulators including officials from the NY Federal Reserve and independent academics on the Swap Reform committee have commented on the merit of this design and its ability to help with their stated objectives such as; reducing reliance on Libor, reducing friction on the Fed Wire System, eliminating fails related to futures deliveries and reducing the notional value of the existing Swap market.

Central Banks who manage a large portfolio of US Treasuries have always desired a more straightforward futures product.  This design allows natural buyers of US Treasuries to write Puts on upcoming Auctions and earn additional income on their holdings in the form of covered call writing.

Large Banks have seen the two-fold efficiency of the product to reduce balance sheet and reduce margin requirements.  Concentrating liquidity and following a Futures type structure in the options market are seen as beneficial.

Non-traditional Liquidity providers immediately recognize the potential of this design and will eagerly provide markets and liquidity to support the product set.

Large End Users who are concerned about the current market structure love this product set and the ability of it to reach a wider audience.  They question the ability of the large banks to provide liquidity in a debt market that has recently quadrupled with balance sheets that are reduced in some cases by over 80%.

Exchanges see how this product set allows for cross product pollination and solves the awkward ratios and limitations between yield based Eurodollars and prices in 32nds of Swaps and Treasury futures.  This product set will provide tremendous interaction.  The recent announcement closing of the CME floor will increase the difficulty in trading between instruments and provides further opportunity.

Complimentary White paper can be found by clicking here.

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