The Russell is in for a major shake-up in September when Russell 2000 (full and E-mini) contracts traded at CME Group go off the board and the only place to trade Russell 2000 futures will be the Intercontinental Exchange (ICE). It will be the most established contract to change venues since Eurex was able to wrestle control of the Bund from Liffe.
Last June, Russell Investment Group and ICE signed an agreement giving ICE exclusive rights to list futures and options on futures on the Russell family of indexes. It ended a three-year experiment where Russell licensed its indexes to multiple exchanges. Prior to that, CME had an exclusive license on the Russell 2000 and the New York Board of Trade had an exclusive license on the 1000.
CME is offering several alternatives in an attempt to hold onto the open interest in the Russell 2000, which otherwise would move to ICE with the contract, but the question is, what will pension managers and traders do in the face of the transition, and how will it work?
“This is going to be quite interesting. You’ve never had a really successful product in the (U.S.) futures markets transferred from one exchange to another before. And to what extent the customers can have the facilities to just start trading it on a new venue is an open question,” says Jeff Shaw, head of trading at Timber Hill.
The Russell complex includes the broad-based Russell 3000, the large cap Russell 1000 and the small cap Russell 2000. In March, ICE signed a cross-margining agreement with the Options Clearing Corporation, which clears equity options on the Russell indexes and on Russell ETFs. ICE also launched an incentive program in which CME, Chicago Board of Trade, Chicago Board Options Exchange and New York Mercantile Exchange members may trade mini-size Russell futures contracts and options on futures contracts at the ICE member rate of $0.30. “With more people getting started, we wanted to offer value and straightforward pricing in response to the growing interest in the Russell mini on ICE as we move toward the June roll,” says Kelly Loeffler, vice president of corporate communications at ICE.
One of the reasons Russell chose to list contracts on ICE exclusively is because ICE committed to promoting the 1000, which theoretically could challenge the S&P 500. “We are very happy with what we’ve seen from ICE,” says Sara Wilson, client executive for Russell Indexes. “Russell is their only equity index product and they are dedicated to marketing our entire index family.”
Thomas Farley, president and COO of ICE Futures U.S., says, “What a lot of customers are saying is, ‘we’re excited about the switch [because] we know you guys care about the success of the Russell family and we’re using Russell products to hedge across many different funds and we want to see those funds succeed.’ There’s a high confidence level that the Russell 2000 will succeed anywhere, but [due to our exclusive arrangement], people are excited about the other indices and the potential growth there.”
ICE expects the transition to begin over the summer, but experts seem to be split about when users will transition their contracts from CME to ICE. “The liquidity will stay in the CME until September. No one [wants to] be the first one in the other contract,” says Michael Buek, principal at Vanguard.
“You’re going to see a steady migration throughout the summer,” says Christopher Ailman, chief investment officer of the California State Teachers Retirement System (CalSTRS). “If you’ve got to put your toe in the river, somebody’s got to be the first. And if we show up, a lot of other institutional investors will start showing up as well.”
How participants are going to make the transition is another important piece of the puzzle. Buek offers the following strategy: “Everyone will trade the September [contract] in the CME and when the Sept is about to expire and if they want to continue a long or continue a short in the Russell 2000, they’ll have to roll in the ICE. Someone who’s long in the CME, around September, would buy the ICE calendar spread. Basically they’ll buy December Russell 2000 ICE contracts and sell September Russell 2000 contracts. So their position in September will be long one CME Russell 2000, short one ICE Russell 2000, so that’s a non-trade, and then they’ll be long one ICE December. When the Septembers expire, you’ll be long in ICE December and I expect the ICE December contract to trade the same exact way the Russell 2000 is trading now,” he says.
Shaw agrees with this assessment, saying, “People will look to trade the Russell September/December calendar spread on ICE and allow their CME Sept position to expire.”
While Ailman doesn’t offer specifics on how CalSTRS would transfer its open interest, he says, “Over time we’re going to roll out of our contracts to the physical securities anyway and we’ll implement that into our process of shifting from one trading location to another.” He adds, “We’re going to trade initially in small size. It’s like the movie Field of Dreams: ‘build it and they will come.’ I often say, ‘trade it, and they will come.’ I think we will and I’m going to push us to continue to be part of the trading volume, but we’d like to see other institutional advisors so that there’s a narrower spread.”
Liquidity is the main concern of many pension managers. “[I’m more concerned that] the players who trade in the Russell 2000 stay in it,” Buek says. “It’s about the liquidity. The most important thing is that the players are there.”
Ailman says, “We’ve been very vocal with Russell that we’d like to see more open interest in those contracts. We’re a mega-billion dollar investor, [so] when we move in the futures markets, we need liquidity; we need size.” ICE is confident that the liquidity in the Russell contracts will transition smoothly to their platform. “Our focus has been on [retaining] the most liquidity on day one to build open interest very quickly,” Farley says.
CME Group is not taking the loss of the Russell lying down. “Staff has been working with customers to explain how alternative products are cost effective to trade [and] to educate customers on calendar spreads,” says David Lerman, director of CME Group equity products. CME is touting its E-mini S&P Small Cap 600 contract as an alternative to the Russell, and is offering an incentive program and waived fees for both Small Cap 600 and Mid Cap 400 products. The E-mini S&P Small Cap 600 contract is .9956 correlated to the Russell 2000 and has similar 20-day historical volatility, Lerman says. CME also is attempting to get end users to transfer their Russell open interest to an SMC-ER2 Intercommodity Spread Listing on CME Globex and is offering an EMD-ER2 Intercommodity Spread Tool between E-mini S&P Mid Cap 400 and E-mini Russell 2000 futures. Timber Hill’s Shaw says the EMD-ER2 tool “might convince some portion of the business to stay at CME, but the bulk will still end up transferring to ICE.” CME will continue to offer futures on its iShares Russell 2000 ETF after its Russell contract expires. As to whether users will trade the ETF in lieu of Russell futures, Buek says, “There’s a lot of people that need futures, but to the extent they can substitute and they need Russell 2000, I could see it happening.”
Ailman calls CME’s alternatives and incentives “too little, too late.” “The bottom line is, the S&P 500 super composite doesn’t cut it when it comes to people like us who are trading along the Russell 3000. We want the ability to trade the Russell 1000 and 2000 contracts. That is the best way for us to manage our portfolio, hedge our risk, and eliminate any basis risk of dealing with other equity contracts,” he says.
For Buek, the attractive qualities of the index itself are the most important reasons to trade it, regardless of the trading venue. “I don’t think ‘CME’ when I trade the Russell 2000. I don’t even think ‘Russell.’ I think good, small cap futures index that has a lot of liquidity. For all I know, the real center could be in my garage,” he says. Shaw says, “It’s going to be interesting to see how much of what happened in the Russell was due to whatever advantages CME and Globex had and to what extent it’s due to the product itself.”
This is a good point, as some people wonder whether ICE’s electronic platform is a match for Globex in terms of speed and efficiency. “People are pretty used to trading on Globex. They don’t want to have to worry about trading gaps. It’s kind of like the election right now – anything could happen between now and then,” says Jim Mooney, president of Infinity Trading
Farley says ICE’s platform is ready for the Russell. “In the Russell world, a lack of latency is important to a large user base, and it’s one way they define liquidity. And we’re the best platform for that,” he says, adding, “We’re going to put all our muscle behind making these Russell products successful. We have a lot of confidence that with the right participants, with the right marketing, with the appropriate technology, that we can make one or several of these indexes quite liquid.”
Many experts agree that although the transition is not without challenges, ICE and its platform are up to the task and it should be a fairly smooth move for the Russell. “My gut [says] it’s all going to follow unless ICE messes something up. If they do, then [everyone will go to] the 600 or the 400. I don’t expect [ICE] to mess up,” Buek says. Ailman expects the liquidity to move to ICE and has very few qualms about the transition. He says, “Any time you have a transition of marketplaces, you don’t want to see a slow trickling. That’s always a challenge because you don’t want to be the first in line and you don’t want to be the last in line. But people who trade these contracts are pretty savvy. We’ll still see a pretty smooth transition. We think it can gain wider investor interest, particularly among the institutional investors. It should bring more institutions to play and will make it a more fluid market.”
Shaw also believes there’s no reason for the contract not to succeed at ICE. “My guess is ICE will spend whatever money they need to allay people’s fears because the last thing they want is for the contract to be a bomb because people say ‘your platform’s too slow.’ They’ve spent all of this money getting the contract, so it would make no sense for them to let it slip through their fingers because they weren’t prepared for the volume.”
