Eurex and ICE square up in European short-term rates

Eurex has stressed its European short-term interest rate derivatives strategy is a long-term project and the focus remains on buy-side firms after the German exchange reported a slowdown in trading activity last month.

The German exchange relaunched on November 1 its Euribor contract backed by incentive schemes to trade alongside the Eurex Euro short term rate (ESTR) future made available in January 2023, two key components in Eurex’s ambitious plan to establish itself as the home of European interest rate derivatives.

The Eurex Euribor contract started strongly, trading 1.6 million lots in November and 1.5 million contracts in December before hitting daily trading volume records on three consecutive days in early January, the last of which (224,000 lots) equated to an almost one fifth market share.

But Eurex’s Euribor trading volume fell on January 11 to 7,000 contracts and traded at about that level each day for the rest of January.

Speaking three months after the Euribor relaunch on November 1, Matthias Graulich, a member of the Executive Board at Eurex Clearing, said the exchange’s Euro yield curve ambitions are based on long-term objectives and draw on its experience of an earlier success attracting liquidity from London.

Graulich said: “To move the Bund was a seven year process and we are in month three with Euribor so I am not concerned at all. We just need to tweak the toolbox to get the stability then I am convinced we will see more taker flow coming over time. The focus now is to get takers on and build open interest.”

Graulich refers to the episode when the Frankfurt-based exchange famously took the Bund futures market, which references the German 10 year government bond, from Liffe (the forerunner to ICE Futures Europe) over a few years in the late 1990s.

Eurex Euribor’s open interest is currently about 10,000 lots, according to the exchange, which suggests most of the trading activity is coming from market-makers rather than buy-side firms.

Lee Bartholomew, global head of fixed income and currency product design at Eurex, added: “The volumes we did in the first two months were very strong and clearly above where we expected to start. We are talking the positives which are the active clients are increasing and we will see a continuation of the build-out overall so the volumes will stabilise.”

ICE remains the dominant market for Euribor futures, trading 31.3 million lots in January, up 29% on the same month last year, while the US group’s ICE Futures Europe’s Euribor open interest is just below 5 million lots, according to that exchange.

Stelios Tselikas, head of interest rate derivatives at Intercontinental Exchange, told FOW, with European interest rates set to fall this year, firms like the certainty of trading in a mature market.

He said: “European interest rates went up in 2022 and 2023, and then in December people started pricing cuts for this year and in that kind of macro-environment firms want to know that they can get in and out of a contract with certainty. There is a saying that liquidity is king but when the market is moving, that is definitely true. With that in mind, our Euribor volumes have done really well at the end of last year and in January 2024.”

For Eurex, the priority is growing the buy-side participation in its Euribor book and here the German exchange plans to draw on its early success in the ESTR market where it is the top exchange by trading volume while CME Group has more open interest than Eurex or ICE.

Bartholomew said: “We continue to be focused on the same things such as increasing the taker volume. If you look at the progress that we are making in ESTR, we are taking the same approach with Euribor where we are looking at building that business over time.”

The relationship between Euribor and ESTR is an interesting one. Europe has established ESTR as its preferred risk-free rate (RFR) alternative to the Libor-based Euribor but, unlike the US, UK or some other major markets, Europe has not mandated a move away from its legacy rate to the RFR.

That said, Euribor and ESTR track slightly different things in that Euribor covers material term and bank credit risk while ESTR is risk-free.

So, for now at least, the Euribor and ESTR markets exist in parallel and there are currently no signs from European regulators that they are about to drop Euribor and force firms to use ESTR.

Bartholomew said: “We believe Euribor and ESTR will co-exist for some time, hence for us it is about building the total liquidity pool. ESTR is important for us because there isn’t an incumbent exchange.”

Graulich added: “Generally, if products are sufficiently different, you can see two liquidity pools in similar products to co-exist. We are still hearing concerns in the market about the composition and fixing of Euribor so maybe developing an alternative liquidity pool may trigger a further though process with regulatory bodies on the future of short-term benchmark interest rates.”

Tselikas also sees the two European short-term rates markets operating in parallel: “The European authorities appear to have agreed that there are two rates – Euribor and ESTR. They used to have Euribor and EONIA and now they have Euribor and ESTR and we see those coexisting comfortably together.”

He added: “One is a risk-free rate, the other has a credit element to it so they help investors manage their exposure in different ways. Our Euribor futures are vastly more liquid than ESTR futures but we are actively investing in building our ESTR futures liquidity so that for the investors who do want to manage European Central Bank exposure via a risk-free rate, they choose to do that at the liquidity on ICE.”

The ICE head of interest rate derivatives said higher interest rates have increased the cost of capital and forced firms to seek out more capital efficient products: “Trading ESTR and Euribor on ICE offers margin offsets of over 90%+. With interest rates going up, options also become very interesting from a more capital efficiency perspective and our options franchise is doing well.”

For Eurex, the European regulatory push to require EU-based firms to clear more of their business with European clearing houses like Eurex is a regulatory tailwind for its European rates strategy.

Graulich said: “We are getting closer to the finish line on EMIR 3 and that likely requires activity in the EU not only on over-the-counter interest rate derivatives but also on short-term interest rates (STIRs). Together with our strong value proposition around capital and margin efficiencies this aspect has the power to mobilise and activate some further takers throughout the year respectively in early 2025.”

The Eurex Clearing board member added: “The EMIR 3 requirements may only become effective late this or early next year but that is something we have always had in mind when we said we need to build a decent liquidity picture for a period of time to be credible and attractive for the natural taker business.”

The dynamic interest rates environment in Europe compounded by the nascent competition between ICE and Eurex in Euribor, and ICE, Eurex and CME in ESTR has also attracted new entrants to the European rates space for the first time in more than a decade.

Tselikas said: “In European interest rates, we’ve seen people coming back into the market and new people coming in for the first time as market-makers, end users, new hedge funds or bank desks get involved.”

He added: “We’ve seen examples of where some interest rate traders who had left to trade other asset classes, crypto or energy for example, are now coming back to rates because they see opportunity in the market again.”