Matif 's strategy in the run-up to EMU


Jacques Werren*

Despite sporadic bursts of Euro-scepticism in some EU member countries, the latest round of European summits — Madrid in December 1995, Dublin in December 1996 and Amsterdam in June 1997 — has brought major advances on the road to European monetary union. And the decision to set bilateral exchange rates for currencies participating in the euro as of May 1998, announced at the Ecofin meeting in Mondorf on September 13 this year, was yet another reminder that politicians are determined to launch the single currency on schedule.

Monetary union means a sudden and dramatic change, creating a huge pan-European capital market overnight. Matif has been hard at work for several months, making concrete preparations so as to be able to offer a range of liquid euro-denominated products as of January 4, 1999.

The euro will usher in a new era for European markets. Its impact on financial markets has already been widely discussed, including:

- adoption of a common monetary policy, to be implemented by the European Central Bank, bringing with it a euro yield curve
- issue of all new bonds in euro as of January 4, 1999
- a steep rise in volume on European bond markets —the world's second largest market behind the US— driven by the elimination of currency risk. In this context, liquidity and credit risk will be the main pricing considerations.
In a word, the euro will bring international investors greater liquidity. At the same time, the elimination of national currencies will reduce the number of domestic products on offer, making fiercer competition between national markets inevitable.

French markets and Matif have positioned themselves to benefit from this new situation. The certainty of French participation in phase III of Emu has been a major plus, allowing preparation for a smooth switchover as of 1995. Market participants have been able to move ahead without second thoughts, co-ordinating their efforts in a unified process.

On January 4, 1999 all sections of the French market—forex, equities, money markets, bonds and clearing systems—will thus switch over to the euro in a single move. The French Treasury has already announced that all existing debt will be converted into euro on the same date—some FF3.5 trillion in all, including FF2 trillion in OATs alone. A critical mass of euro-denominated securities will thus appear from the start, buoying the Matif products derived from them.

Matif will be operating in the world's prime reserve currency after the dollar, encouraging investors to shift into French debt instruments traded on the cash market and through derivatives. The market's size, technical strength and liquidity will work in its favor, other attractions being the system adopted by the Treasury, built around a group of primary dealers as in the US, a liquid strip market, and auctions focusing on a few highly liquid issues. Together these factors have made French bonds a model in Europe.

In addition, banks operating in the euro zone will have access to intra-day refinancing in euro, provided they are established in the zone. By locating in Paris, they will be able to process all types of euro operations, from wholesale to retail, as of January 4, 1999.

Finally clearing and settlement systems used in Paris will shift simultaneously to the euro, and be connected to Target, the pan-European gross settlement system.

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Matif's Emu strategy is reflected in its alliance through Eurex. This is based on shared management of operations in interest rate euro-denominated derivatives and introduction of a unified market system built on four strengths:

1. A single offering of fixed-income products denominated in FRF and DEM, subsequently EUR, under joint management

Plans to build a single, unified market linking Paris and Frankfurt call for a wide range of contracts covering all euro products with appeal for investors, including:

- contracts in French francs (subsequently in euro) based on French securities. These will benefit from the existing liquid market for French Treasury issues, which will get a boost from the immediate conversion of French debt to euro in 1999.
- contracts in D-Marks (and subsequently in euro), based on German securities.
- New euro-denominated contracts to be created jointly by development teams representing both markets.

Existing DTB products will continue to be traded on the DTB system, even following conversion into euro, while Matif products will still be traded by open outcry. In mid-1998, when Matif SA adopts NSC-VF, both open outcry and electronic trading will be used, with all German and French products accessible to Eurex-Matif members through screens developed by GL Consultants.

New products created by Eurex AG and Matif SA, including multi-issuer contracts, will be traded electronically, assigned to a market on the principle of parity and balance.

Taking a closer look at three key points on the yield curve:

In 10-year maturities, we will be able to offer, depending on market conditions, a contract based solely on French government debt converted into euro on January 1, 1999, or a joint contract with Eurex based on debt instruments from several sovereign issuers in the euro zone.

The current Notionnel contract will be replaced by the euro Notionnel, a single-issuer contract based solely on French government debt in view of possible remaining credit spreads; this debt will be immediately converted into euro. The contract will be traded both on the electronic system and by open outcry. The DTB will maintain its Bund contract, transformed into a single-issuer product based on German securities, leaving the choice of benchmark up to the market.

As with the 5-year contract, the French-franc Notionnel will not co-exist with its euro replacement. Nominal value and other features will be modified in March 1998, as soon as March 1999 opens.

5 and 10-year multi-issuer euro-denominated bond contracts may be launched jointly by Matif and Eurex, with features defined by the two partners; this is particularly likely if the French/German spread is narrow and volatility low. Such contracts will be traded only on the electronic system.

At the middle of the yield curve, the Matif 5-year contract launched on September 10 this year is a natural addition to the existing 3-month Pibor and 10-year Notionnel. The French Treasury offers new issues regularly in this segment, and the stock outstanding is both large and liquid. With liquidity in this product judged satisfactory by the market, an option on the same contract will be introduced on October 20.

• Finally, at the short end of the curve, the 3-month Pibor contract. While the euro will not come into being until January 4, 1999, it is already a reality on Matif, where the 3-month Pibor contract is now trading for 1999 and 2000 delivery. Matif SA has taken measures to ensure a smooth transition to Euribor, which is to replace the 3-month Pibor. Once phase III of Emu is under way, the rate will be adopted by the Association Française des Banques (AFB), as is now the case for the 3-month Pibor. The AFB has called for a pan-European rate and is working closely with its German counterpart to develop this new benchmark. Liquidity on the Pibor contract will thus shift to the Euribor 3-month.

2. The DTB and NSC VF electronic trading systems will be linked by shared front-end technology developed by GL Consultants, with a single log-in. Participants will thus be able to access the entire range of contracts offered by Eurex and Matif on the same screen, in FRF, DEM and EUR.

3. A system of cross-membership will be adopted, with harmonization of rules and regulations.

4. Cross-margining for positions taken on the two markets: starting in mid-1998, links between clearing systems at Eurex AG and Matif SA will significantly reduce members' margin requirements, with no adverse impact on market security.

Underpinning this strategy is a drive to reduce market users' costs. To enhance liquidity of euro products, we have cut Matif SA's clearing fee by 30% for all transactions in delivery dates after January 1, 1999, and we are also looking into a fee structure that takes into account the needs of different types of users.

Adopting systems already well on their way to becoming international standards will also reduce costs for financial institutions operating on several world markets:

- NSC Version Future (NSC VF) trading system, which has also been adopted by the Chicago Mercantile Exchange (CME) and Monep; (the Paris Bourse has a version of the same for equities)
- Clearing 21® streamlines clearing with a system already used by the CME and Nymex.

Bringing trading pits for all of Matif's fixed-income contracts onto a single "eurofloor" has reduced users' fixed costs by an estimated 20%. In addition, traders who because of cost were not physically present on two separate trading floors — for long and short-term contracts — are now able to trade all products and thus contribute to liquidity. Finally, it will facilitate certain trading strategies, including cross-contract arbitrage.

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In other words, for Matif the euro is here and now. And we are working closely with our members as well as through the new Eurex alliance to ensure that the switchover on January 1, 1999 is a success.