CBOE Holdings plan to acquire Bats Global Markets for $3.2bn after passing the US antitrust approval process in December 2016 is expected to bolster the capabilities around exchange traded fund options trading of the merged company. SRP spoke to John Deters (pictured), CBOE's chief strategy officer and head of corporate initiatives, about the option's exchange footprint in the exchange-traded products (ETP) market and the firm's plans to capitalise on opportunities in the structured products market and the indexing segment.
Is the Bats acquisition aimed at increasing CBOE's footprint in the ETP segment?
Our appreciation for the ETP product set is not new and goes back to 2007-08 when we began a partnership with Barclays on the VXX exchange-trade note (ETN), which has turned out to be a phenomenal success, not just in terms of the product itself, but also how the product has helped to grow the broader VIX user base. We attribute the success of the VXX product to the simplicity of its structure, transparency and cost.
Those three elements extrapolate to the broader ETP set of products, and over the last few years we have partnered with S&P and others to help launch new ETPs and have seen a number of our benchmark indexes, such as the CBOE BuyWrite Index and the CBOE S&P PutWrite Index being deployed by other product providers. The more work we do with these ETP products, the more our appreciation deepens as we believe this product set has proven itself in the marketplace.
What does Bats add to CBOEs capabilities?
The pending Bats acquisition responds to our needs as a product provider in the value chain. We have been approached many times from ETP issuers and buy-side firms with investment ideas around volatility-related products or options overlay strategies in a simple ETP package. We had the capabilities to help define the strategy and create indexes for investable products, which we did very successfully. However, we did not have the listing capability and that meant we handed off those customers to (other) exchanges at the point of product launch.
For us to really provide the best service to ETP issuers and investors, we need to have a presence in all parts of the value chain. The Bats deal enables us to have that complete value chain presence. We plan to have a compelling story for ETP issuers as we can be with them from inception through trading, promotion and education. We believe this will allow CBOE to increase its market share in this segment and become a strong player in the marketplace. We have the experience and the track record with product development in our options business, and we want to achieve the same level of recognition with our ETP offerings as well.
Bats also has phenomenal connectivity and buy-side relationships across Europe, which will help us better educate the marketplace about our products and expand our reach. Last but not least, our pending combination with Bats will add new cash equities and FX datasets to our existing options datasets, which our research and product teams can now capitalise on to create new product opportunities.
Is the market shifting towards ETPs and away from the OTC structured notes setup?
A significant number of ETNs constructed in the past have lacked transparency, have a high credit exposure and are also highly leveraged, which has not helped their reputation. Having said that, we are fundamentally agnostic to the wrapper. We don't have a view around which exchange-traded fund (ETF), ETN or exchange-traded commodity (ETC) wrapper is more suitable for investors, as that is a question around engineering and the level of risk an investor is willing to take. We believe that some of the risks embedded in structured products such as counterparty risk can be addressed through better engineering, such as using listed derivatives and systematically collateralising the note. There are ways to minimise issues such as counterparty risk, transparency, liquidity and cost, even on an ETN.
Will the Bats acquisition help CBOE's expansion in Europe's ETP market?
We see significant opportunities in this segment given the growing popularity of ETPs in Europe as demand for hedging strategies continues to grow. Although US equity options market volume was down 10% on an industry wide basis in 2016, volume in ETP options increased by 7%. We think we can take advantage of that demand and leverage the pending Bats acquisition to boost our position in the US options market. In Europe there is also potential to provide hedging products for ETPs, although that market might not develop as in the US. In Europe, we see opportunities around index options to help investors hedge their ETP exposures.
In terms of the growth of the underlying ETP market in Europe, we think it is a matter of time. The trends and the demands are there and we think the assets under management will continue to grow. There are challenges, such as the fragmentation of the marketplace. However, because the Bats business was created as a Pan-European platform, we will be able to respond to that demand across countries.
What's your view on structured products?
As with the different ETPs, we are agnostic about structured products as long as they're engineered correctly with the right simplicity, transparency and fee structure. We are aware that in Europe and Asia, structured products have been a preferred product for certain retail and high-net worth investors. We will continue to look at ways to tap into that space. Now that we have a presence in Europe, we believe we can leverage the product packaging capabilities of our asset management affiliate, CBOE Vest, and the platforms developed by the CBOE Vest technology team. We are working together with our European team to potentially offer solutions for the structured products market.
Do you see opportunities around the use of ETFs as underlyings for structured products?
Using ETPs as underlyings is an example of how structured products can be engineered in an efficient way and overcome some of the flaws of past structured products. This is a very interesting way to address simplicity, transparency and cost in structured products, as you can provide cost-effective exposure to listed assets. We are also exploring how we can leverage our indexing capabilities and relationships with product issuers to bring such structured products to market.
For example, the CBOE Stabilis Index, an asset rotation strategy index, uses the CBOE Volatility Index (VIX), a US S&P 500 volatility indicator, and the CBOE/CBOT 10-year U.S. Treasury Note Volatility Index (TYVIX), a US Treasuries volatility indicator, to target allocations between three ETPs and cash, in different proportions. We have back-tested this index in all types of market conditions and the index outperforms many other types of investments over time.
Will CBOE's index business remain a core activity going forward?
We have a broad family of indexes (options strategies, volatility, buy write, put write, etc.) that are used in a wide range of ETPs and structured products. Recently we rolled out a social media index (CBOE to develop social media-based strategy indexes for structured notes and ETF providers) and we are looking at other ways of expanding our offering and bringing to market new value-added indexes. We also plan to leverage Bats' capabilities (Bats launched recently a set of benchmark indices in Europe) to expand our combined offerings in the index segment.
Is there a lack of education around the ETP product set?
Lack of education can be an impediment to bringing unique new products to the market place. For this reason, education has always been an important element of our offerings. Just as we do with equity options and index options, we plan to provide education and support around ETPs, structured products and any other packed products that can add value to investors. Education is key to making new products successful.
What are CBOE's plans in the short term?
We have a very strong collection of capabilities to create an interesting proposition around new product creation. The focus in the short term will focus on closing the pending acquisition of Bats and then integrating CBOE's and Bats' combined capabilities to make sure we provide a seamless offering. Ultimately, we want to be a one-stop shop for issuers and product partners to turn cutting-edge investing ideas into successful tradable products."
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