ISDA highlights a selection of research papers on derivatives and risk management         

Establishing a Foreign Exchange Futures Market in China

International Monetary Fund
By Zhongxia Jin, Yue Zhao, and Haobin Wang

The paper analyzes the importance and urgency of setting up a foreign exchange (FX) futures market in China. It also examines the impact of FX futures markets on the volatility of spot markets. Additionally, the authors suggest that regulatory design changes are necessary for the establishment of a well-functioning FX futures market in China.

Currently, China’s over-the-counter FX derivatives market is mainly an interbank market that offers customized products to large companies and institutional clients. An FX futures market is needed to encourage a broader participation of market participants with hedging needs, such as small and medium-sized enterprises.

The onshore FX futures market can also help resolve regulatory challenges associated with an oversized offshore market. Finally, the establishment of an onshore FX futures market will enable cross-border investors to better manage FX risk.

The paper examines whether the establishment of FX futures in emerging markets increases the volatility of the underlying spot FX markets. The authors demonstrate that FX futures markets do not increase the volatility of the spot market, and, in some cases, volatility decreases.

The authors suggest that China should phase out the underlying exposure documentation requirement for derivatives traders. This regulatory approach can impede the development of China’s derivatives markets. Instead, regulators should allow for a more market-based approach to ensure stability of the FX futures market.

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Do the SDGs Affect Sovereign Bond Spreads?

By Eline ten Bosch, Mathijs van Dijk and Dirk Schoenmaker

The study analyzes the connection between a country’s performance in meeting the United Nations’ Sustainable Development Goals (SDGs) and its sovereign bond spread. The authors use the SDG index as a proxy for a country’s sustainability level, and five-year sovereign credit default swap (CDS) spreads as a proxy for the credit component of sovereign bond spreads.

SDGs measure a government’s commitment to achieving sustainable development by 2030, and include social, economic, and environmental goals. The SDG index is constructed as an equally-weighted index of 17 SDG goals.

The analysis covers a wide range of low- to high-income countries. It shows a significant negative relation between a country’s SDG index and its CDS spread. This effect is stronger for a longer time horizon.

The results imply that investors may consider sovereign bonds of countries that score relatively highly on the SDGs as less risky. Countries with a high SDG index will have lower future SDG-related expenses, decreasing the impact on their future fiscal balance. However, a higher SDG score does not mitigate risk for the counties that have higher exposure to climate risk.

These findings suggest that a better SDG performance may benefit governments financially, resulting in lower sovereign bond yields and greater bond proceeds. However, only key social goals are priced into CDS spreads. Performing well on environmental goals does not currently provide financial benefits.

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Who Trades Bitcoin Futures and Why?

Commodity Futures Trading Commission
By Alex Ferko, Amani Moin, Esen Onur and Michael Penick

The study analyzes the composition of traders in bitcoin (BTC) futures and micro BTC futures contracts. The analysis is based on a data set comprising end-of-day positions of large traders in CME BTC futures contracts.

The analysis classifies traders into three types: concentrated, diversified and hybrid. Concentrated traders hold more than 80% of their portfolio in BTC futures. Diversified traders usually have less than 20% of their portfolio in BTC futures. Hybrid traders on average hold between 20% and 80% of their portfolio in BTC futures.

Data shows that most BTC traders either hold almost exclusively BTC futures (concentrated traders) or have large portfolios in which BTC futures contract comprise only a small part (diversified traders).

The percentage of diversified and concentrated investors has changed over time. In the second quarter of 2020, there was an increase in diversified traders accompanied by an increase in the share of short interest held by these traders.

The composition of traders in micro BTC futures contracts differs from BTC futures. The analysis finds that while there are many concentrated traders in this market, the majority of open interest is held by diversified traders.

The study also analyzes how BTC futures contracts are connected to other futures contacts. The authors find that BTC traders hold concurrent positions in energy, precious metal and equity index futures. Additionally, traders hold other cryptocurrency futures when they are available.

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