! ! ! ! ! !! !!Derivatives Going Why Are Listed Dividend !! !! !! !! Mainstream? !! !! !! !! !! !! !! !! !! !! ! ! February 2016 As listed dividend derivatives become a mainstream liquid asset class, more and more players are using these lowrisk, centrally-cleared instruments to hedge dividend exposure and protect income streams. DerivSource talks to Stuart Heath, Executive Director and Head of the London Representative Office of Deutsche Börse AG. Q. Demand in listed dividend derivatives has grown considerably in recent years. Do you think this asset class is becoming more mainstream? If so why? The answer is yes – dividend derivatives have become an asset class that is identifiable in its own right. There is significant risk in dividends within financial instruments globally, and particularly in Europe. There are a lot of structured instruments available in Europe, and dividends form a risk element of these. The growth in dividend derivatives has been symptomatic of the growth in structured products. As listed dividend derivatives become more liquid, we are seeing additional uses of these products, along the lines of hedging the dividend exposure or income streams for asset managers. As the granularity of the instruments themselves, and the total assets they cover has increased, they have become of more use to more players. ! ! Q. Who are the major users of listed dividend derivatives? What is their motivation for using them? The usage of listed dividend derivatives has broadened significantly. The key primary users were structured equity derivatives desks at European banks, which used them mainly for hedging. For example, if they are listing or issuing auto-callables, they have a dividend risk dynamic that changes with the underlying stock, and they use dividend derivatives to hedge those risks. ! This initially led to almost a structural imbalance. There were sellside firms trying to hedge dividends—who were generally better sellers of dividends. The main buyers were those that could actually wear the risk in the meantime, for example hedge funds, that understood what the dividends were likely to be at the expiry of these instruments, and would take on the immediate risk from the banks. ! Now that they are priced far more in line with what the market expects, and more players have come into the market, you are seeing a broader range of people using the instruments to hedge. For example, straightforward option traders would now potentially look at where the dividend values or the dividend index futures are trading, before pricing up an equity index option. ! Under the European regime, where dividends themselves have become less certain and more risky, you now have asset managers trading individual dividend futures just to lock in the income streams that they have. With more granularity in the instruments provided, there is now a wider set of applications for them and a wider set of users. ! “Listed Dividend Derivatives are low-volatility instruments, which enable you to achieve returns, or express your view with regards to income, potential growth of the company, and therefore distributions of the company, without necessarily exposing yourself to the market fluctuations of the underlying stock itself”. ! ! ! Q. What is the biggest attraction to listed dividend derivatives? CCP risk management is a key element. The fact they are centrally cleared makes the dividend derivatives we list on Eurex low risk. This is important because a lot of these instruments are fairly longdated. Index dividend futures at Eurex go out to ten years, so you have the opportunity to manage ten-year exposure to the dividend payout. On top of that, you have the simplicity of the instruments themselves. With index futures, if you look at the price on the screen, that represents the number of index points that the dividends are anticipated to achieve in terms of the underlying index itself. When it comes to individual or single-stock dividend futures, the price you see on the screen reflects the annual expected dividend for each of those companies listed. ! So it’s a combination of both the simplicity of the instrument, which therefore makes the liquidity and pricing more obvious, and of course the risk management element that a listed CCP-backed derivatives product has. ! ! Q. Is there an advantage to using listed dividend derivatives that you believe generally investors are not aware of and should be? With listed dividend derivatives, we are looking at an annual slice of the dividends payable for an individual equity, or on top of that, the constituent equities within an index. It’s clearly a beneficial instrument for the hedging of income streams. ! But also, if you are looking at the prospective growth—or in this case decline—of prospects within the European companies sphere, listed dividend derivatives are low-volatility instruments, which enable you to achieve returns, or express your view with regards to income, potential growth of the company, and therefore distributions of the company, without necessarily exposing yourself to the market fluctuations of the underlying stock itself. ! ! By isolating a particular element, an asset manager may feel he’s got more of an advantage in terms of achieving alpha. Q. A key difference between exchange-listed dividend futures and OTC traded dividend swaps is the counterparty risk. As the market is more risk-aware, do you expect more investors to move towards futures? ! I think what we’ve seen in Europe is probably going to be symptomatic of what you will see globally. With the benchmark Eurozone index, EURO STOXX 50 ®, the bulk of the market has now moved to listed futures and away from the swaps market. Obviously there are some swaps still trading, but these tend to be far more bespoke—they are matching exact periods that dividend futures do not cover because of some specific instrument. We have also seen overall market volumes increase from their original OTC volumes. ! As you add more instruments, and more granularity—Eurex now lists single stock dividend futures, rather than just the EURO STOXX 50 ®, as well as constituents of other major European indices—and given the importance of counterparty risk, particularly when that risk is for a longer date, I think you will see more of a move towards futures globally. ! Europe is the most developed dividend derivatives market at this point, but other geographic regions are now also starting to move into that sphere with listed products. ! ! Q. What do you expect to be the biggest development in this space in 2016? Is it the launch in other jurisdictions for instance? As I mentioned, Europe is the most developed and most sophisticated dividend derivatives market, but of course the US has significant dividend players. They don’t tend to be so focused on the dividend itself—maybe because it is paid quarterly, so the risks are less annualized. They have also been a bit slower in listing these products—S&P dividend futures, for example, have only just been listed in the US, and haven’t seen much pickup yet. There isn’t the underlying structured product market there to generate massive demand. But now that they are listed in the US, I can see demand going up for US dividend derivatives, as well as a lot of US demand for European dividend derivatives. We weren’t previously able to tap this demand because dividend products weren’t regulated in the US and therefore couldn’t be listed. !! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! Stuart Heath is Executive Director and Head of the UK Representative Office of Deutsche Börse AG where he focuses on Eurex Derivatives business. Stuart has been Head of the Eurex/Deutsche Börse London representative office since July 2010 having spent the previous three years working on product development at Eurex and latterly designing and managing listed dividend futures and options products which were launched in 2008. Prior to joining Eurex Stuart held positions in credit and fixed income trading, covering both credit default swaps and corporate bonds at Daiwa SMBC and previously at Greenwich Natwest/RBS. Stuart also has experience in the risk management side of the industry with HSBC. Stuart has over 20 years experience in finance and holds BA (Hons) in Accountancy and Finance and an MSc in International Banking and Financial Studies from Heriot-Watt University, Edinburgh. * This feature was originally published by DerivSource.com. !
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