Listed futures could boost property derivatives
International derivatives exchange Eurex will launch property futures in the first quarter, a move that could improve liquidity. The first contracts will capture the annual returns on the IPD UK All Properties Total Return index. With the introduction of IPD Index futures, Eurex aims to work with present market participants to provide the benefits of an exchange-traded contract and to attract new market participants and liquidity.
"We look five to 10 years out for products of the future," says Stuart Heath, who is responsible for product development for property futures at Eurex in London. "Real estate is an asset class without any exchange-traded products and could be quite robust in the future. As far as we’re concerned this product will have benefits for direct investors. They will be able to build real estate portfolios quicker than direct investment, in a smaller lot size and without stamp duty."
Eurex plans to follow the initial UK All Property offering with UK sector contracts such as retail, office and industrial in the second quarter. It is also looking at French and German All Property contracts, if there is enough demand. "Real estate companies will only get excited for sector-level products," says Heath. "[Over-the-counter] sector products are not doing well at the moment, there is very little liquidity, but if the product becomes more transparent and available in smaller lot sizes, it could pick up."
From Heath’s point of view, another big selling point of the exchange-traded contracts is that Eurex provides the clearing facility, which is important in this market where there is a risk of counterparty bankruptcy. Another benefit, according to Heath, is the standardized contract, which will trade in relatively small lot sizes of £50,000.
"Ultimately, any mechanism that allows more users to get involved in property derivatives will encourage the growth of the market," says Richard White, head of property derivatives at Knight Frank in London.
The IPD UK All Property index is at present the most actively traded for over-the-counter property derivatives. As the credit crunch has rolled on, IPD’s volumes have dropped. The total volume of IPD property derivatives traded in the third quarter this year fell 38% on the previous quarter, to £1.15 billion ($1.72 billion). A total of 166 trades were executed during the three-month period to September 30, recording the lowest number of trades since the third quarter of 2007. This decline has not discouraged Heath.
"A lot of people are wary of using derivatives right now. But because of lack of liquidity in the direct market, next time around managers will use derivatives as a liquidity facility," says Heath. "It will give fund managers more tools and allow them to have a more liquid fund. They will be able to play markets both ways – not just on the way up."