E-mini S&P 500 ESG futures – Answering the liquidity question

Source: CME Group

E-mini S&P 500 ESG futures are the most liquid ESG futures on the globe, but some investors are still concerned whether liquidity is strong enough to meet their needs. This article seeks to identify where liquidity is today and highlight how the product is more liquid than it may seem, allowing potential investors to explore the product more thoroughly.

ESG and sustainability continue to be at the forefront of many investors’ minds, and whilst many investors are incorporating ESG in their securities-based portfolios, many are still at an embryonic stage and considering incorporating ESG-based derivatives. This is beginning to change quickly, and after COP 26, the focus will likely accelerate.

The E-mini S&P 500 ESG futures contract has just reached its two year anniversary and has quickly established itself as the most liquid ESG equity index futures contract on the globe. This fact has been corroborated by third party research such as by Graham Capital and others.¹ The chart below shows the contract’s accelerating ADV and open interest, and given liquidity begets liquidity, this pattern can be expected to continue into 2022. ADV for 2021 is about 1K contracts per day and open interest is currently just over 14K contracts (circa $3B notional) and reached a record of over 22K in the Sep expiry week.²

Source: CME Group

Many prospective investors analyze the liquidity and OI numbers of the contract, and if their expectations are higher than where the contract is today, they might quickly dismiss the contract. Taking a closer look at the liquidity profile behind the contract can be illuminating and lead to a different conclusion.

Whilst this contract is an ESG alternative to its parent contract (S&P 500 futures), it’s unrealistic to expect that the liquidity should be similar to E-mini S&P 500 futures given that the parent futures contract is the most liquid benchmark equity index future on the planet. What is true is that the S&P 500 and S&P 500 ESG indices are extremely highly correlated³ and thus the liquidity found in the E-mini S&P 500 futures can be easily transferred into the S&P 500 ESG futures variant.

So, what does the liquidity look like today? Below is an analysis of the typical bid-offer in terms of basis points and the depth available in different hourly windows throughout the day. We do this for the most recent full month of data (October 2021).

Figure 2 shows that the bid-ask spread during US hours when the underlying stocks are open is extremely liquid with a bid-ask of approximately two basis points. The top of book size on the touch is on average 10 contracts ($2M notional) whilst the first three tiers of displayed depth totals circa 35 contracts ($7.2M).⁴

Source: CME Group and OneMarketData

Given many of the early adopters in the ESG space are out of EMEA, it is worth highlighting what liquidity is like in the EMEA morning. Many clients want to transact out of US hours and Figure 3 below highlights that liquidity is still tight during the London morning. The typical bid-ask is five basis points wide, and the contract is up in seven contracts ($1.4M notional) on the touch and the first three tiers of liquidity has a total depth size on average of 19 contracts ($3.9M). Investors are indeed taking advantage of this out of US hours liquidity, as seen by the fact 20% of all Globex trades in E-mini S&P 500 ESG are occurring before the US cash market opens.

Source: CME Group and OneMarketData

The tight bid-ask spreads seen in both the US and EMEA morning hours are indicative of the fact liquidity is available. It is also worth noting that the figures quoted above are the resting displayed sizes. When trades occur these top of book quotes generally replenish, given the strong arbitrage channel between the parent E-mini S&P 500 futures and the ESG version. This arbitrage channel also ensures the ESG contract is unlikely to run away from order book activity, as some clients perhaps perceive may be the case with futures contracts where there is lower liquidity.

Indeed, if one looks at the activity overall in the product, 67% of all trades in 2021 have been on the Globex orderbook (either via outrights or BTIC). Thus, only 33% have been via blocks. This split between screen and block activity is a strong indicator liquidity is available, as typically with illiquid contracts, the volume is usually concentrated in block trades. In addition, block liquidity provision in the contract is very competitive with many of the banks competing to be number one in the ESG space and prove their ESG credentials by winning ESG-related orders.

Clients with large S&P 500 exposure who are interested in migrating to a more S&P 500 ESG exposure have sometimes expressed concerns around capacity of their position vs. the current open interest of the S&P 500 ESG contract. The strategy of many early adopters of the contract has been to allocate an initial amount to the ESG contract and scale up over time as the OI increases. Given this is the case for several investors in the product, each new client allocating to the product has a positive multiplier effect which increases both the OI and the liquidity of the contract.

In conclusion, the E-mini S&P 500 ESG futures contract is growing quickly and investors should assess the real liquidity behind the product and not just look at the raw data. The index has a robust index methodology that is considered Article 8 compliant by SPDJI and this, together with the S&P 500-like risk and return profile it offers, is attracting investors. The more quickly investors adopt the product, the quicker it will become an even more useful trading tool for the ESG investing community.

¹“The Viability of Using ESG Equity Index Futures in Graham’s Systematic Strategies” – by Graham Capital, October 2021.

²As of 19 November 2011 – source CME.

³99.4% daily correlation over a one year period up to 18 Nov 2021 – source BBG.

⁴Data source: CME and notional quoted based on 18 November 2021 contract value.