Riskless Basis Cross Transactions
Description
A riskless basis cross transaction is a trade where an approved participant and a client engage in prenegotiation discussions to agree upon the terms of a transaction on index futures contracts and on share futures to take place outside MX's electronic trading system.
The trade must include the acquisition of a cash market position by the approved participant. The terms agreed upon also include the required amount of index (in the case of index futures) or underlying cash instrument (in the case of share futures) exposure and the basis spread between the average price of the cash exposure acquired by the approved participant and the index or share futures contracts that will be crossed to the client.
General reasons for the use of riskless basis cross transactions
Approved participants receiving requests from clients who cannot or do not want to hold cash securities in their accounts but who wish to acquire market exposure in the most efficient way possible (either on the cash or ETF markets) are authorized to do a riskless basis cross. The sole purpose of the riskless basis cross is to allow market participants to use the attributes of the underlying cash market to take the market position requested by the client and then to replicate it through the use of futures contracts—leaving the approved participant with no resulting market position and the client with a futures position.
Once the terms of the riskless basis cross are agreed upon by the client, the approved participant takes a position in the cash instrument in its own account on behalf of the client. The approved participant then executes the riskless basis cross and allocates the futures position, functionally equivalent to the cash market exposure (as initially requested by the client), into the client's account.
Riskless nature of the transaction
MX allows the use of a riskless basis cross to trade index futures (SXF, SXM, SCF, SXA, SXB, SXH and SXY) and share futures provided that the approved participant's final position is riskless and does not impact the cash market. A long (short) position in the cash market will be offset by a short (long) position in the futures contract. The risk offsetting features of this transaction will transform the net position of the approved participant into the equivalent of a short-term money market instrument maturing at the futures contract expiry.
The provisions that 1) the exposure is acquired at an average cash market price and 2) the riskless nature of the position on the approved participant's book, ensure that these trades will not disrupt or displace the exchange-traded markets.
While the approved participant must acquire the cash market position before executing the futures leg, MX does not impose any time limit for the retention or liquidation of the cash market position by the approved participant. Once the riskless basis cross has been completed, the approved participant may manage the positions on its book as it sees fit. This will further harmonize the transaction with the TSX Basis Trade facility, which similarly does not impose any retention or liquidation requirements.
Pricing of the futures contract transaction vis-à-vis the cash market
The price that the client pays for an index futures contract or a share futures contract has two components: the cash market average price and the basis. This price is obtained in the following manner:
- Basis: The client and the broker agree on the basis that the client will pay above and beyond the cash market average price. This basis is negotiated between the broker and the client.
- The client and the broker agree on the time period during which the broker will acquire exposure to the index or the underlying cash instrument. The average price of the cash instruments is calculated for this period.
- The client's final price for the futures contracts is the average price of the cash market plus the pre-negotiated basis.
The price of an index futures contract (or share futures contract) reflects very closely the price of the index (or the underlying instrument) on the cash market, the difference between the two being the basis (futures price = cash price + basis). While the price of the futures contracts transaction that forms part of the riskless basis cross may be outside the posted market, the acquisition of this exposure through transactions on the cash market firmly sets the price of the transaction in the prevailing market.
Reporting a riskless basis cross to MX
To execute a riskless basis cross, the approved participant must provide the details of the concluded transaction by filling out and submitting the prescribed Contingent Trade Reporting Form to MX's Market Monitoring Department. The form is available through the Web page Contingent Trade Reporting Form. Once submitted, the riskless basis cross will be registered by the Market Monitoring Department in the trading system. The transaction will then be specially marked and displayed in the systems (trading platform and data vendors) at the post trade recap level.
There is no minimum time required to display (by the approved participant) the riskless basis cross before its execution. As soon as it is reported to the Market Monitoring Department, the transaction will be registered and displayed without delay.
Once concluded and registered, the riskless basis cross transaction will appear on the Transaction Report Web page.
The riskless basis cross transaction is excluded from the daily settlement price procedures, but it is included in the daily volume figures.
Audit trail requirements for riskless basis cross transactions
Approved participants involved in a riskless basis cross may be required to demonstrate to MX:
For index futures
- that the transaction is comprised of at least 80% of the components constituting the underlying index;
- that the futures portion of the transaction replicates the underlying index and that components of the underlying index that are not included in the riskless basis cross were justifiably excluded (as described above) from the transaction;
- that the cash portion of the riskless basis cross has a minimum correlation of 90% to the underlying index;
- whether the transaction's pre-negotiated basis was fixed and established prior to the execution of the transaction or resulted from a guaranteed closing or executed price of the cash component;
- that the cash position and the futures contracts position (resulting from the riskless basis cross transaction) are properly recorded in both the approved participant's and client's accounts.
For share futures
- whether the transaction's pre-negotiated basis was fixed and established prior to the execution of the transaction or resulted from a guaranteed closing or executed price of the cash component;
- that the cash position and the futures position (resulting from the riskless basis cross transaction) are properly recorded in both the approved participant's and client's accounts.
While the approved participant must acquire the cash market position before executing the futures contract leg, MX does not impose any time limit for the retention or liquidation by the approved participant of the cash market position. Once the riskless basis cross has been completed, the approved participant may manage the positions on its book as it sees fit.
For more riskless basis cross information, please contact our Market Monitoring Department at 1-888-693-6366.