MIAMI – A municipal futures contract can be a useful risk management tool for many in the marketplace, attendees at The Bond Buyer’s National Municipal Bond Summit here were told.
In a presentation entitled “Better municipal risk management through municipal futures,” Ron Valinoti, principal at Triangle Park Capital markets and manager of MBIS, and John Coleman, principal at R.J. O’Brien, updated the attendees last week on the progress they are making in bringing a new index to muni participants, hedge fund managers and market makers.
The original municipal bonds futures contracts were traded on the Chicago Mercantile Exchange from 1985 to 2004. There were separate muni futures contracts for March, June, September and December which were cash-settled based on The Bond Buyer’s Municipal Bond Index.
Many market participants felt the original contract was an effective tool risk-hedging tool for its time, when changes in the muni contract closely tracked changes in Treasury bond futures, the municipal‐over‐bonds spread and visible supply. However, volume plunged with advent of electronic trading and the muni market’s initial resistance led to the contracts’ eventual demise. There were also concerns about the contract's vulnerability to manipulation by unscrupulous traders.
One problem today is that munis are the only fixed-income security that cannot be effectively hedged.
MBIS and R.J. O’Brien are aiming to create a muni futures contract that will offer an effective hedge for long positions and an opportunity to gain market exposure when supply is low. Their approach is to make the contract -- aimed at sellers and hedgers, buyers and market makers -- objective, transparent and immune to market manipulation.
“We’ve spent a lot of time talking about who would be buyers, who are the market makers,” Valinoti said. “And there is no shortage of people who want to short the muni market.”
He said they expect to launch a tradeable instrument by the Fall of this year and offer muni participants "a way to manage a risk in a way that they can't manage today.".
The firms want the muni spread futures contract to include: MBIS muni benchmark; rates benchmark; delta (the ratio comparing the change in the price of a muni to the corresponding change in the price of its derivative) between muni and rates; and benchmark spreads day over day.
“The thing we are trying to make is a basis contact,” Coleman said. “Most everybody that has risk in the municipal market today has some form of eliminating the duration risk or the actual interest-rate risk."
He said the new contact would be a single product "that can be used by any institution and quite a few individuals as well."
MBIS is a group of 10 firms that specialize in municipal inter-dealer brokerage and have created a consortium for the purpose of aggregating market data generated by their businesses.
R.J. O’Brien is a fully diversified, integrated Futures Commission Merchant with client segregated assets of about $3.9 billion. The fixed-income group focuses on institutional clients.