Portfolio managers who trade futures on the Russell 2000 small-cap index will have to contend with a unique transition challenge this northern summer when the popular contracts move to ICE Futures U.S. from the CME exchange.
Institutional investors, with an estimated $4 trillion benchmarked to Russell indexes, use the contract for pure hedging or to gain exposure. Never before has a major U.S. financial futures contract moved from the market where it was first listed to another. That shift raises several technical issues, from margin costs to clearing. But the Russell 2000 exchange move might prove that innovators, such as IntercontinentalExchange Inc., the Atlanta-based parent of ICE Futures, do not need to wait for cumbersome regulatory changes to throw the gauntlet at their competitors. “We compete head to head with Nymex (New York Mercantile Exchange) in oil and natural gas. We compete head to head with Euronext.liffe for sugar and coffee. This is one more example where ICE is competing with another exchange. As we compete, is there more innovation in the industry? Yes, and at an outstanding rate,” ICE Futures’ US President Tom Farley said in an interview.
Prior attempts by European exchanges to snatch a share of trading in Chicago flagship financial listings — such as the eurodollar or 10-year Treasury futures — failed because of the clearing and operational difficulties of closing a position on one venue and reopening it on another. This time, though, investors have no choice: Russell Investments, which designed the small-capitalisation equity index, has ended its agreement with the CME and gave ICE Futures rights to exclusively trade the contract by no later than September. Get used to volume “There may be some disruption around the date of the change, and maybe some afterwards, as ICE gets used to handling the volume,” said Greg Eisen, senior portfolio manager at ICM Asset Management in Spokane, Washington.
Some 60 million Russell 2000 contracts traded on the CME in 2007. “We have not really taken this into account as a factor in our strategy. It has not hit my radar yet. The September deadline gives people enough lead time to adjust. It’s good that it’s not in June, because Russell does its rebalancing at the end of June. That’s enough of a disruption right there, without throwing in any mechanical disruption,” added Eisen, whose firm and its affiliates have US$7.5 billion in assets under management. ICM alone manages US$426 million in index investments.
Some 99.7 per cent of the volume in Russell 2000 futures is still traded on the CME, although investors had the opportunity to start moving their positions to ICE Futures last year. Some of the transition strategies could revolve around the expiration of the June contract, because waiting for the September expiration might create a volume stampede at the last opportunity to exit CME positions in possibly volatile market conditions. Other index futures might be affected by price swings in the Russell index if the transition does not take place in an orderly manner. “Our estimate is that some movement of positions will take place with the June [contract] cycle where some Clifton clients would move their Russell 2000 futures positions to ICE during the roll phase,” said Jack Hansen, chief investment officer at The Clifton Group.
Clifton manages US$21 billion in equity index listings, which include exchange-traded funds and options and futures on the index. “The way it should happen with most parties would be to buy the calendar spread (offsetting positions on two contracts with different expiration dates) on ICE; investors will get long the September contract and short the June contract. Through that spread transaction, the June short positions will match long positions for the June contract on CME,” Hansen explained.
Margin costs Margin costs are likely to be affected as well: Russell 2000 investors who own other CME index contracts can net all of their positions and benefit from a margin offset. But buying the Russell 2000 contracts on ICE Futures might increase margin costs at first, as investors might not have offsetting positions there. Transaction costs also could be affected because the CME still has deep liquidity in that listing. While liquidity builds up progressively on ICE Futures, spreads could be wider at first, providing an opportunity for sophisticated arbitrageurs of the two markets.
While ICE paid upfront a significant premium to lure Russell’s flagship index to its platform, it was not greed or fear of the CME’s overwhelming growth that clinched the deal. “As an index provider, our most effective method of competing is as an index family. We did not feel we were going to be able to expand futures products without making this move to ICE,” said Kelly Haughton, founder and strategic director of Russell Indexes. “ICE is committed to the Russell 2000, but also to having a family of Russell products.”
With derivatives on the Russell 1000 and 3000 indexes already on ICE Futures, the Russell 2000 move puts all Russell contracts under one roof. According to industry sources, Russell executives were disappointed that the large-cap Russell 1000 futures contract failed to build any volume on the CME, where it traded between 2003 and 2007.
The Standard & Poor’s 500 remains the dominant index at the CME, where executives also are pushing new index futures to replace the Russell 2000.