Every morning, it seems someone else launches an electronic credit derivative trading platform; it’s difficult to keep up with it all. At the beginning of the year, traditional voice trading was the dominant form, yet it now seems to be going the way of the dinosaurs. An enormous sea change in market practice is under way.
Distinctions have to be made between the various online credit derivative trading systems in the market. Some function only on a dealer-to-client basis, such as the platforms launched recently by BNP Paribas and Barclays Capital, but the products that are really changing the market are the broker-run, dealer-to-dealer platforms.
Of the latter, there are several systems in operation at the moment: RealTime, run by credit derivatives broker Creditex; CreditMatch, operated by GFI; PrebonEdge, run by Prebon Global Credit using Trayport technology; and Brokertec, a general online broker-dealer platform run by Garban-Icap on which credit default swaps (CDS) can now be traded. Tullett & Tokyo also has a screen in operation, and in mid-November Axiom announced the launch of a CDS trading platform as well.
Of these, it is fair to say that only those screens run by Creditex and GFI have made a real impact on the CDS market yet and of these two Creditex appears to have claimed the lion’s share of the electronic market. RealTime was unveiled in February of this year and receives almost universal plaudits from the market.
“I would say Creditex has 90–95% of the electronic market,” says Charles Longden, global head of structured credit trading at ABN Amro in London, while stressing that in terms of overall volume traded other brokers are much bigger than Creditex. He adds that the broker screens operated by other shops have made limited impact on the market. Another senior dealer agrees, “Creditex is leagues ahead. It is unbelievable compared to the others. Garban and GFI are not yet there in terms of quality.”
The message was echoed by dealer after dealer. “I like them all, but in general everyone knows who is the market leader: it’s Creditex,” says one. “Dealers will go to the system that has lots of liquidity, it’s that straightforward,” he adds.
“It’s my perception and the perception of the market that Creditex are number one,” says yet another dealer at a major shop. “They have had a classic first-mover advantage and their technology is very good,” comments the head of a desk at a major shop.
Since Creditex launched RealTime, it has traded in excess of $107 billion of notional principal online, it says. And this has increased from week to week. In the month of October, it traded an average of $1.3 billion a day in notional principal.
According to Grant Biggar, head of Creditex Europe, 99.9% of these trades are now completed online. This represents an astonishing change in trading behavior in less than eight months. Both Biggar and Mazy Dar, head of online trading at Creditex, confirm that they were greeted by considerable skepticism and often downright hostility from banks when they first unveiled RealTime. They admit to being caught by surprise by this dramatic shift in trading behavior.
Biggar adds that RealTime is the culmination of a long process. “Although we migrated to voice broking in 2001, we continued to invest heavily in technology,” he explains.
It is no secret that credit derivatives electronic trading has made more progress in Europe than in the US. It is estimated that volumes are four or five times greater in the London market than in New York, and brokers that have introduced electronic platforms admit that they have adopted a ‘Europe first policy’. Nonetheless, online dealing in the US is under way, and, if the experience of the London market over the last year is anything to go by, significant volumes of US credit derivatives will be traded this way by the end of 2005.
However, it is perhaps unfair to compare GFI and Creditex in this manner. GFI’s CreditMatch is a truly hybrid instrument, with elements of electronic and voice broking incorporated into the same system. It makes no difference whether trades are executed through the screen or voice, it’s the overall volume the counts, claims GFI, and in this respect they are confident that they are still streets ahead of Creditex.
If GFI does 30 trades in a day, only 10 might have been executed exclusively online, but the screen will have played a part in capturing the remaining 20, says GFI global head of product marketing Michel Everaert. “All trades are integrated. It doesn’t matter if it’s voice or screen or a combination of the two,” he argues.
RealTime and CreditMatch are the only systems that should be compared, he adds. “Trayport is an energy platform adapted for credit, Brokertec is a bond platform adapted for credit. Only CreditMatch and Creditex are ground-up platforms for CDS,” he says.
And while Creditex has secured undeniable strength in electronic trading, it cannot match GFI’s strength in traditional voice broking. “GFI is the only broker strong on both sides of the fence,” he says. CreditMatch was launched internally in December of last year but was made accessible to dealers in August. The first banks to go live on CreditMatch were Barclays Capital, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan, Lehman Brothers, Merrill Lynch and SG CIB.
A dealer can see a price on the screen and can choose to trade it simply by double-clicking on it. Alternatively, the dealer might choose to call the broker and trade on the phone. “Sometimes dealers want to keep it off screens,” Everaert explains. Whenever a broker receives a price on the phone, he enters it into his screen. The screen that the broker sees is different from the dealers, and a broker can see which house is responsible for each price.
GFI clearly believes that there is still very much a place for voice broking. Yet the widespread acceptance of screen-based trading this year indicates that there have been several key developments recently to make this possible. Creditex was founded in 1999 and introduced its first internet-based trading platform the next year. It was not a success, and the firm realized that the market was not ready for it at the time.
Things have now changed: firstly, documentation is standardized. The Isda Master Agreement for credit derivatives was introduced in 2003, whereas three years ago terms would have to be discussed in some detail. The vexed question of restructuring as a trigger event still divides the global market, yet London and New York have found their own consensus.
The liquidity of the market has also grown enormously in the past three years. Electronic trading allows market-makers to handle the larger volumes through an efficient price dissemination process and reduced transaction costs, says Dar.
However, perhaps the biggest change in the market in the past three years has been the establishment of unified indices by iTraxx earlier this year. “One cannot overestimate the importance of the indices. It was crucial in kick-starting the electronic trading of CDS,” says Creditex’s Biggar. “However, now more than 60% of our trading volume is in single-name credit default swaps.”
ABN’s Longden agrees that the iTraxx indices have been of incalculable importance in the commoditization of the market and the enhancement of liquidity. When asked what has changed in the market over the last three years since Creditex and GFI first started developing screen-based dealing functions, he says simply, “Three years ago we didn’t have credit indices.”
Gary Smith, managing director of Icap, also isolates the launch of the unified indices this year as the catalyst. “The merger of the two indices was significant for the development of e-trading for CDS. We felt that market liquidity would increase enough for CDS to trade successfully on an e-platform,” he says. Icap launched electronic trading of CDS through its Brokertec platform on November 1.
Bid-offer spreads in the indices are now very narrow. On the RealTime screens, the iTraxx indices trade in quarter-point margins. And liquidity is now sometimes better than in the government bond market, adds Longden.
Before traders would take to screen-based trading without reservation, however, two fundamental and at first glance incompatible requirements had to be satisfied. First, any screen system had to have great clarity and to show bid-offer prices that were tradeable. Second, the system must provide dealer protection. Dealers are most concerned that they cannot be picked off online.
Consequently, both Creditex and GFI have devoted time and attention to the incorporation of various safeguards into their systems. On RealTime, for example, if a trader enters a price that is more than 10% outside those posted in that credit in the last five days, a warning screen pops up.
Users of both RealTime and CreditMatch can also choose to put up bids or offers for a limited period of time. If, for example, they know they are going into a meeting in 10 minutes, they can opt to post a price for just 10 minutes while they are in front of the screen.
RealTime and CreditMatch give dealers the option to pull all prices if a designated credit in the same sector trades. Michel Everaert of GFI adds that safeguards are important in CreditMatch, for example allowing a broker to pull prices on behalf of clients if he believes it to be appropriate. “You really need to provide all the protection tools you can to give traders confidence to put up prices on the screen,” says Creditex’s Dar.
When a trade is completed on RealTime, a box appears which reads: “Please be aware that this trade test is the electronic equivalent of hearing ‘You are done’ from a voice broker. All post-trade confirmations need to be completed.” All users of the system have credit clearance to deal with each other. The top 20 CDS market-makers use RealTime, says Dar.
All RealTime index trades are in lots of $25 million; those on CreditMatch are also in lots of $25 million. On both GFI and Creditex, counterparties have the option to increase the size of the trade, which is entered anonymously. If one counterparty decides to increase a single-name CDS trade to $10 million, and the other decides to increase to $15 million, then $10 million will trade. The identity of counterparties is only revealed after the trade is completed.
Gaining an edge
Competition for desktop real estate is fierce, and GFI and Creditex have been at pains to incorporate features that they hope will give them the competitive edge. “The market is still hugely competitive and we are still looking for differentiating aspects,” says Evereart—so much so that he was loath to isolate particular aspects of his system for fear of giving away too much information to the opposition.
Some dealers seem to prefer the Creditex system. “Creditex works: it’s well designed and dealers like it. The trade posts are excellent,” says ABN’s Longden. Features that were particularly liked by other dealers were the filters, by which trading information on certain sectors can be delivered to the user while other sectors are blocked out. One dealer says that the audits were very good. “It is a very intuitive system,” says another dealer.
“It was the first one in, and it has the best technology. It’s very simple and dealers like simple,” says an experienced CDS trader. He adds that there were no features of the other systems that he didn’t like, but Creditex had the great advantage of being “the first to the party”. Creditex had been dealing for six months before GFI released CreditMatch.
“The technology is very good and it’s easy to use, but it’s not like it’s not replicable,” says a senior dealer at a US shop about RealTime. “They have definitely made an impact, and you’ve seen the other brokers scrambling to introduce their own systems.”
One trader offers a more even-handed view of the technical qualities of the two systems. “They all have features that are good and some that are bad,” he says. In particular, the “general display” of RealTime is considered “very interesting”, but it needs more customized pages. “GFI has more tailored pages,” he says.
In fact CreditMatch and RealTime are both closely related. “In terms of functionality, there’s very little to choose between the two,” says a dealer who uses both screens. What distinguishes the two systems is liquidity, and in this respect RealTime still has the edge. “Creditex has had the best liquidity in screens,” says a dealer. Brokers always gravitate to pools of liquidity
However, GFI has been making up ground. “GFI has caught up in terms of liquidity in screens in the last few weeks,” says a dealer of single-name financial credits at a London shop. Of course, GFI would also argue that the whole debate about screen-based liquidity is missing the point, as it is overall liquidity that is important.
Online trading via Icap’s Brokertec’s screens has been under way for only a few weeks, but MD Gary Smith says the early signs are good. It has been installed at 15 banks and “the number of electronic trades increases every day.”
Like those at GFI, Smith agrees that the role of the voice broker is still significant, particularly in the development of trading in the less liquid, less commoditized instruments. The hybrid of voice broking and e-broking is the “winning combination” he says.
Although Icap has yet to make a real impact on the electronic CDS market, when asked to compare Icap with its rivals, Smith says, “I do not think that there is a single broking company that has the diversity of products or the strength in voice and e-broking that Icap has to make a valid comparison.”
Brokertec is gaining ground as well, says a dealer. Along with Icap, Brokertec has been “very aggressive” in marketing its systems. For example, Brokertec has launched a promotion offering a commission holiday in the European index products until January. You can’t get much more aggressive than that. Creditex also offered a commission holiday when it got going.
Prebon announced live trading of European indices on PrebonEdge on September 13. It claimed at the time that it was the only true hybrid credit derivatives trading platform on the market. The platform is based upon Trayport’s Global VisionT technology, which is already used in Prebon’s energy trading platform.
Underlining the rate at which electronic trading of CDS has gathered momentum in the last few months, Trayport’s commercial director Elliott Piggott said at launch, “The speed with which the platform has been tailored and implemented means that Prebon is now in an excellent position to capture the surge of interest in trading credit derivatives online.” (Icap and Prebon were unable to provide screen shots by time of press.)
The message from the market is for once loud and fairly unambiguous: in the world of electronic trading of CDS, Creditex is considered ahead of the pack. It is benefiting from a virtuous circle whereby liquidity begets more liquidity. But, stresses one dealer, “it doesn’t mean the others can’t catch up.”
Screen-based trading in general has also benefited greatly from the abnormally low spread volatility that has characterized the market for much of this year. “Very little volatility and compressed spreads leads to beneficial conditions for screen trading. When prices are moving around, people are less keen to trade on screens. When Rhodia moved from 500bp to 900bp, it wasn’t trading on screens,” says the head of one desk.
Another dealer agrees, “Creditex has been the beneficiary of a historically low volatility environment and of the indices merger. It dominates trading in indices, and it makes sense.”
So although a low-volatility environment has aided the acceptance of screen-based trading, voice trading will come into its own again when spread movements become more unpredictable. When a credit is moving around rapidly, dealers need the color and context that only a voice broker can provide before committing to a trade. And even though the CDS market is currently characterized by a period of exceptionally low volatility, sudden shocks can still send markets into a tailspin.
This is the point that GFI stresses. Creditex may have better screen-based liquidity at the moment, but screen-based trading is not the be-all and end-all. “Two weeks ago, we had a sudden period of volatility in the financial names and the screens went black. Then you need voice brokers,” says GFI’s Everaert. A dealer at a clearer agrees, “In the less liquid, less transparent names, voice broking is still an advantage.”
Even Creditex is keen to emphasize that RealTime does not make brokers redundant. “Screens don’t replace relationships. You need regular interaction with the traders, particularly in single-name CDS, to ensure the screen is populated and tight bid-offers are crossed,” says Biggar.
On October 14, New York attorney general Eliot Spitzer announced an investigation into price fixing in the insurance industry. US broker Marsh & McLennan was the focus of the inquiry, and its five-year CDS subsequently vaulted higher. It was trading at 27/28bp on Thursday October 14 before the news, and hit 225bp on Monday October 18.
It closed on Tuesday at 243bp and was reported to have hit a high of 305bp on Wednesday—a move of 270bp (or 1,000%) in just over four sessions. Not only would it have been undesirable to trade this credit on screens during this period of frantic volatility, it would have been impossible to do so.
|What happened to CreditTrade? |
Four years ago the burgeoning CDS market was looking over its shoulder at the successful introduction of electronic trading platforms across a range of markets, including fixed income, equities, futures and oil. Two credit derivatives broking firms, CreditTrade and Creditex, were going head to head to be the first to capture CDS volume online. Both had electronic trading platforms in the market but the challenge was who would be the first to dominate the new game.
Both attempts foundered, but while the fight was still on CreditTrade commissioned a private global survey of the state of play in the CDS world and its readiness for an online platform.
John Parry, director of Rostron Parry and part of the research project, remembers those winter months of 2001 well, and says that both CreditTrade and Creditex were fighting for a share of a market that did not yet exist. “There was a sense that the industry would need a platform but only one. Thus, there was competition to develop that one platform before the market actually wanted it and before the volume figures could sustain it,” he recalls.
Dealers at the time also said that the CreditTrade platform that was launched was considered slow, difficult to navigate, provided no market colour and was not user-friendly. Creditex was said to be friendlier but still less effective than voice broking. Crucially, the market saw little need for either as all deals still had to be concluded by phone, which was seen as the more reliable form of trade execution.
In fact, the structure and pattern of the CDS market in those days militated against the successful development of an online platform. Liquidity, though growing rapidly, was much less than it is today. Moreover, liquidity tended to be spasmodic and concentrated in specific sectors.
“There wasn’t any consistency in instruments traded. One quarter it would be in industrials, another quarter it would be in telecoms and in the third quarter it would be pharmaceuticals,” says Parry.
In essence, there was little uniformity or standardisation to the instruments traded, and the basis of any online trading platform is uniformity and standardisation. Parry was amongst those who concluded that a platform that might revolutionise the market could include such features as audio alerts for changes in bids or offers, voice recognition, instant access to a historical database of trading prices and text links from screen to broker.
Since its early attempts at launching an online platform, CreditTrade has failed to produce a viable product. “GFI are still going great guns, Creditex have pulled their socks up but CreditTrade are not doing very much,” says someone familiar with the situation at CreditTrade.
CreditTrade does intend to launch an online CDS trading platform “relatively shortly”, according to managing director Paul Ellis. “We do have something, but we are not making a song and dance about it,” he adds.
The week in Risk.net, May 19-25 2017Receive this by email