ICE Futures US Equity Basis Block Trades: A New Way to Price Block Trades in Certain Equity Index Futures

Effective December 13, 2022, ICE Futures U.S. (IFUS) is implementing new functionality under its block trade rule permitting dealers to trade “equity basis blocks” (EBBs) in IFUS futures contracts on MSCI Indices, the NYSE FANG+ Index, and the ICE Biotechnology and Semiconductor Index. Similar to the CME’s “derived blocks” (introduced for certain CME equity index futures last May – for which, see here), an EBB is a block trade, the price and quantity of which depend on hedging transactions by the dealer that takes place after the terms of the block trade have been agreed, but prior to being submitted to the exchange. Permissible hedging vehicles include stock baskets, cash market instruments, or equity index futures or options. Per the IFUS FAQ, the hedging instruments “must demonstrate a reasonable price correlation to the equity index futures product underlying the EBB.”

A dealer trading EBBs may commence hedging activity upon having reached an agreement with its counterparty on the quantity of futures or notional value of the block, the execution methodology for the hedging transactions, the markets on which the hedging transactions will take place, and the predetermined basis to be used in determining the price of the block trade after the hedge has been established.

EBB trades and the corresponding hedge transactions must occur and be submitted on the same business day and reported to IFUS (via ICE Block) no later than 5:45 pm ET. The “execution time” for an EBB trade is the time at which the participants agreed to the terms of the block trade in principle (therefore, prior to the commencement of the hedging activity that will establish the actual price). ICE Block will include an option for reporting a block trade as a “Basis” trade type, as well as a “Transaction Details” field which the submitter should use to report the basis and the hedge instruments used for pricing. Upon request by the exchange, dealers must be able to provide additional detail concerning those hedge instruments, the volumes traded, and the prices at which each instrument was traded.

If a dealer is unable to execute the full quantity of hedges necessary to support the originally agreed quantity of the block trade, the dealer must, at a minimum, submit the block trade at a quantity that corresponds to the number of hedges actually executed. Alternatively, with the counterparty’s consent, the dealer may submit the block trade up to the full quantity originally agreed. The IFUS FAQ is silent on what market participants should do in the scenario where the hedge quantity consummated is less than the required block trade minimum threshold, but it’s fair to infer that, in that case, the dealer should submit the trade at that minimum threshold (or, up to the level originally agreed, as may be agreed between the parties). Notably, where the CME’s derived block guidance permits a dealer in effect to walk away from a derived block for which the dealer was unable to establish a sufficient hedge to meet the applicable minimum block trade quantity threshold, the IFUS guidance appears to require the dealer to execute an agreed EBB at least to the level of that threshold.     

As with CME-derived blocks, dealers transacting in EBBs will want to fully disclose to their clients how the trade works under the applicable regulatory guidance. It’s important that clients understand, going into a derived block or EBB trade, that there is a risk, assumed by the client, that the trade as originally agreed may not be consummated at the level originally agreed if the dealer is unable to establish a sufficient hedge.

 The text of IFUS’s regulatory guidance on EBBs is available here.