Three-year futures on Korean local-currency bonds are among the most actively traded bond futures in the world. Yet activity on 10-year futures has been virtually nil since it was introduced two years ago. That may now change.
The Ministry of Strategy and Finance, the Financial Services Commission and the Korean stock exchange (KRX) have announced that, as of October, the 10-year futures contract can be settled with cash, not just with securities, as is the case today.
Buy-side bond traders say this technicality is meaningful. The three-year contract can also be settled in cash, which is one reason why it is so successful - some 14 million three-year bond futures contracts were traded in the first half of the year, according to KRX.
Yet the 10-year futures contract was essentially rendered dead on arrival when it was introduced in 2008 with only securities settlement. In such a transaction, one party must deliver bonds, but may not own them outright. That means such participants must buy the bonds in order to settle, and if the market is aware of such a need, those bonds have a way of suddenly becoming very expensive.
As a result, no one shorts bonds to trade the 10-year futures contract, which means it is useless as a means of shorting the market or serving as a hedging tool. Only in a market as deep as the US can securities-settled bond futures contracts still attract market backing.
Once Korean 10-year futures contracts can be delivered in cash, traders expect the market to succeed. That should have plenty of positive knock-on effects along the domestic yield curve.
A successful 10-year futures contract would bring liquidity to longer-dated securities and enhance the ability to hedge against inflation. It is also a precursor to building an efficient repurchase (repo) market. It will allow Korean companies to issue longer-dated bonds in greater size and at more attractive pricing, and let fund managers manage their duration risk more accurately.
"This is an important step to allowing the market to price the entire yield curve," says one asset manager's head of Asian credit trading in Singapore. "Korea has issued bonds across the yield curve, which should support futures trading."
Assuming the 10-year cash-settled futures contract is indeed a hit, traders hope other governments will notice. "Asian countries need to liquefy their domestic markets, and to do so they need active swaps and futures markets," says another trader, also based in Singapore.