TMX’s Government Bond Futures Market Shines

TMX Group is starting to reap the benefits of a multi-year strategy that has seen the Toronto-based exchange group develop a full suite of Canadian government bond futures contracts and make them available to the world through extended trading hours, by Luke

Montréal Exchange (MX), the derivatives arm of TMX, has for years offered a deep and liquid market in the Ten-year Government of Canada Bond Future. This year, the Five-year Government of Canada Bond Future has continued its recent strong growth trajectory with volumes up more than a third and volume in the Two-year Government of Canada Bond Future, which only launched two years ago, has exploded.

Simon Hughes, Head of

Jeffs

Institutional Sales at TMX, said: “The Canadian market has grown up in recent years and we now have the whole curve in place from the front end STIR (short-term interest rate) contracts all the way through to 30 years which we never had previously.”

Hughes is quick to reference Canada’s strong investment credentials – a mature, open market with world-class regulation supporting a solid, G7 economy

– while admitting the exchange group’s fixed income market is benefitting from the fast-changing macro-economic environment.

“We are in a unique situation from an economic standpoint. In the past ten years since the Global Financial Crisis, central banks were all racing to cut rates and even go negative, leaving little room to trade the front end of the curve, but we don’t have that problem anymore. Now, we’ve got diverging central bank policies, we have inflation spiking in certain parts of the world, we’ve got commodity countries, including Canada and Australia, doing exceptionally well.”

Hughes added: “We’ve also got divergence in currencies with the Japanese Yen hitting 150 to the dollar and the Pound nearing parity against the dollar so finally we are seeing a lot more alpha back in the market. We’re getting curve inversions in the bond markets and curves steepening elsewhere so there are huge opportunities now.”

“Coupled with this, our launch of the two year futures was one of the last pieces of the yield curve jigsaw and followed the successful five year futures launch around four years ago. We can safely say this has become a key contract for the Canadian market.”

He added: “Getting the five years off the ground took a lot of hard work as well as support from the Canadian banks. Mortgages are fixed off the five-year part of the curve in Canada so it was always critical to make this contract a success. Once successful, it allowed us to develop curve strategies around the 5, 10, 30 ,, and subsequently the 2 years.”

The Two-year Government of

Canada Bond Future (CGZ), which only launched in late 2020, traded in the 10 months to the end of October over 4 million lots, up an impressive 170% on last year.

The Five-year Government of Canada Bond Future (CGF) traded in the year until the end of October 7.5 million lots, an increase of 33.8% on last year, while volumes in the flagship Ten-year Government of Canada Bond Future (CGB) were flat on last year at 27.7 million lots, according to the exchange.

The longer-dated 30-year Government of Canada Bond Future (LGB) is less liquid, but Hughes is equally optimistic about the prospect at the longer end following some recent technical changes to the contract specs.

“In terms of contracts, the 30-year should really come back strongly in January since we tweaked the contract due to the ‘wild card’ option on the physical bond coupon.”

Hughes said trading in the March 2023 contract of the MX 30-year Government of Canada Bond Futures contract has resumed with the new spec which has reduced the delivery period to a single day.

Canada, like the US and the UK, is also moving away from IBOR-based lending rates to so-called risk-free rates (RFRs). The Canadian RFR is the Canadian Overnight Repo Rate Average (CORRA).

For Montreal Exchange, this means winding down its futures product that references an IBOR rate– the Three-month Canadian Bankers’ Acceptance Future (BAX)and replacing it with a Three-month CORRA Future.

Hughes said: “The BAX contracts this year have come off slightly because we are at an inflection point where CORRA is going to be taking over from the BAX contract. ”

MX’s BAX trading volume has fallen 37% this year on last year to 12.5 million lots in the ten months to the end of October while trading in the alternative CORRA futures has rocketed from a low base to 210,000 lots over the same period.

And these numbers should continue to rise from early next year as Canada has established January 9 as the first of two CORRA First days when its dealing banks will switch en masse to quoting swaps with CORRA rather than the previous standard.

Hughes said: “CORRA is very much front-of-mind with us. January will see all the banks start to use CORRA for swaps and so we will see the transition gain momentum in the next three to six months.

“We are starting to see volumes build already with CORRA’s open interest at over 30,000 lots and growing. BAX open interest is currently around 750K contracts however so we should not forget there is a long way to go but once the swaps start it will be the trigger.”

Asked if the transition to CORRA presents any opportunities for TMX, Hughes added: “We may get some of the more focused European funds to start to look at it [CORRA] whereas they haven’t looked at it before, thinking of Canada as the third market [after the US and UK]. Our job is to ensure that it is liquid, supported and it is widely recognized for its unique value.”

The growth of the TMX government bond futures business is partly due to increased international participation in the Canadian market made possible by TMX’s long trading hours spanning Asia and Europe. About 5% of TMX volume is outside of Canadian trading hours and about a fifth of volume within Canadian hours comes from outside of Canada, according to the exchange.

Hughes said: “We’ve got a Hong Kong Operation now with four people. Clients there mainly trade the SXF (S&P/TSX 60 Index Standard Futures) and the ten-year contract with growing interest in the fives and twos out of Asia. At some stage we hope to launch CORRA contracts in Asian time zone.”

TMX extended its trading hours in two phases, to include Europe in 2018 and then to cover Asia in the middle of last year.

Hughes said: “The extension to include European hours was a great success and that opened us up at 7am London morning whereas the Asian hours now take us to 20.5 hours. For example, a fund based in Australia can start to trade later in the day in Australia and then follow the sun with their orders.”

“They still do the bulk of their trading when Canada is open but the liquidity is growing all the time. The ten year trades very actively trade but we are now seeing liquidity flow into the five and two years.”

Hughes has a particular interest in Australia as the former head of European capital markets for ANZ, a position he held for nearly five years before seven years as head of EMEA fixed income distribution at Canadian bank TD and joining TMX in 2019.

He said the extended trading hours combined with the maturing product set is also attracting a broader range of trading clients.

“We’ve had a lot of support from the liquidity providers, the prop shops and the banks but we are getting more and more asset managers, sovereign wealth funds and central banks. It’s really important to get a mixture of clients because you want the hedge funds and props to do the STIR contracts out to five years and you want the asset managers to trade the fives, tens and thirties while the sovereign wealth funds are a bit of a mixed bag.”

With investors keen to avoid problems in other parts of the world by boosting their allocation to North America, Hughes wants funds to look at Canada: “Anyone can trade the US. As a fund manager or hedge funds, you want to stand out from the crowd by making more alpha so I would say step away from the herd, there is the opportunity to make good returns in Canada.”

Copyright © 2022 Bourse de Montréal Inc. All rights reserved. Do not copy, distribute, sell or modify this document without Bourse de Montréal Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Limited nor any of its affiliated companies guarantees the completeness of the information contained in this publication, and we are not responsible for any errors or omissions in or your use of, or reliance on, the information. This publication is not intended to provide legal, accounting, tax, investment, financial or other advice and should not be relied upon for such advice. The information provided is not an invitation to purchase securities or derivatives listed on Montreal Exchange, Toronto Stock Exchange and/or TSX Venture Exchange. TMX Group and its affiliated companies do not endorse or recommend any securities referenced in this publication. BAX, CGB, CGF, CGZ, CRA, LGB, Montréal Exchange and MX are the trademarks of Bourse de Montréal Inc. TMX, the TMX design, The Future is Yours to See., and Voir le futur. Réaliser l’avenir. are the trademarks of TSX Inc. and are used under license.

The S&P/TSX 60 Index and the S&P/TSX 60 ESG Index (the “Indices”) are a product of S&P Dow Jones Indices LLC or its affiliates (“SPDJI”) and TSX Inc. (“TSX”). Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); and TSX® is a registered trademark of TSX. SPDJI, Dow Jones, S&P and their respective affiliates do not sponsor, endorse, sell or promote any products based on the Indices and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions or interruptions of the Indices or any data related thereto.