Anchored three-year yield spurs ASX to introduce five-year futures

Increased issuance from the AOFM – including targeting maturities of 3-5 and 10-12 years – and the Reserve Bank of Australia (RBA)’s intervention in the Australian sovereign bond market have accelerated Australian Securities Exchange (ASX) thinking about a new contract in its bond futures suite. The exchange is planning to introduce a new five-year contract by the end of the year.

The reserve bank has committed to anchoring three-year Treasury bond yields at 0.25 per cent for the foreseeable future, which has had the effect of greatly suppressing volatility at this point on the curve.

With around A$175 billion (US$121.1 billion) of Treasury Bonds already on issue between the three- and 10-year futures buckets and the expectation of plenty more to come, hedging in the mid-curve space was already an important requirement for many market participants. This has become harder to do using the existing futures contracts alone.

Helen Lofthouse, executive general manager, derivatives and OTC Markets at the ASX in Sydney, explains: “In the past, users might have hedged ‘in-between’ exposures using a mixture of three- and 10-year bond futures contracts. But there is a question about whether this approach will create the right hedge when the three-year is subject to yield-curve control [YCC] while the 10-year is still moving.”

The pickup in Treasury bond issuance and RBA intervention may have brought consideration of a new contract to the top of the ASX’s agenda. But the concept was already under consideration prior to recent market developments.

“We think it makes sense to have a five-year point on the curve anyway and it is something our customers were asking for even before YCC,” Lofthouse comments. “What’s different now is that we believe market conditions will help generate early liquidity at the five-year point.”

“In the past, users might have hedged ‘in-between’ exposures using a mixture of three- and 10-year bond futures contracts. But there is a question about whether this approach will create the right hedge when the three-year is subject to yield-curve control.”

HELEN LOFTHOUSE AUSTRALIAN SECURITIES EXCHANGE

The ASX says the contract listing is expected to come late this calendar year, subject to regulatory approval and market readiness. The first expiry month is likely to be March 2021. The exchange also plans to complement the five-year contract with new spread products, including a 3-5 year and a 5-10 year, to add to the existing 3-10 and 10-20 spreads.

The exchange is currently engaging users – including trading and clearing participants and their vendors – as well as regulators and other stakeholders in preparation for the launch.

Market participants seem to support the rationale behind the new listing. Anthony Morriss, Sydney-based head of Australian and New Zealand economics at Bank of America, says the RBA’s success in controlling three-year Treasury Bond yield has made the five-year part of the curve more attractive for investors. He expects the forthcoming ASX five-year futures contract further to increase demand in this part of the curve and says it should also facilitate issuance.

Once introduced, the new contract will remain part of the ASX suite on an ongoing basis – regardless of whether and when the RBA lets the three-year bond yield float freely again at some future point. It will also add to the existing three-, 10- and 20-year bond futures, all of which will continue to be listed on the ASX.

Lofthouse tells KangaNews: “Our expectation is that there will be enough issuance in the physical market to support liquidity between the three- and 10-year points on an ongoing basis. In fact that liquidity already exists, even without the AOFM’s issuance profile changing very much.”