Prime broker of the year: HSBC

Risk Awards 2024: Bank’s open and collaborative approach to risk management pays dividends

Vivek Sarohia, Brian Horgan, Gemma Laman, Vincent Bonamy
Vivek Sarohia, Brian Horgan, Gemma Laman, Vincent Bonamy
Photo: Geraint Roberts

Trading with leverage can often bring unpleasant surprises, such as the margin calls that nearly brought down liability-driven investment funds last year in the wake of the UK government’s catastrophic “mini-budget”.

With this in mind, HSBC’s foreign exchange prime brokerage division has been trying to take some of the mystery out of how margins are calculated.

The bank’s head of global intermediary services, Vincent Bonamy, says “accuracy, transparency and stability” underpin how the FXPB team approaches risk management: “If you are accurate in the way that you assess risk and have a transparent dialogue with the client, that gives you a stable framework, and clients recognise that.”

As part of this drive towards transparency, HSBC has this year rolled out tools that enable clients to assess the interest rate sensitivity of calendar spreads and vega risk in FX options when calculating margin requirements. These measures have contributed to a year-on-year increase of $115 billion in client balances and a double-digit rise in the bank’s notional trading volumes.

“Many banks have their margin methodology as a kind of intellectual property and they don’t usually share it,” says a large US-based client. “HSBC seems to be more transparent about it, which enables my treasury team to replicate it. This means we can foresee how much HSBC may charge us on a given day if we do a certain trade, and that is super-helpful.”

Multiplication tables

Multi-strategy funds have come to dominate the landscape, with firms such as Citadel and Millennium combining different types of strategy – such as long/short equities, macro and volatility – irrespective of whether markets are rising or falling. Some funds also involve multiple portfolio managers within the same strategy. As a result, prime brokerages have to try to accurately assess the risk of a client running multiple strategies, or “pods”.

In response, HSBC has implemented a consolidated risk approach that focuses on optimising cross-product offsets within portfolios.

“Sometimes it’s as simple as being able to run reports and being able to see the risk at that individual [portfolio manager] level in real time, whereas traditionally, it would be booked at that net level,” says Gemma Laman, the bank’s global head of platform sales, FX.

The new interest rate environment has also placed greater stress on the traditional margin framework. An increasing number of clients are using calendar spreads to express a view on interest rates, either on an outright or relative value basis – for example, by simultaneously buying a one-month EUR/USD forward and selling a three-month EUR/USD forward. Although the trade offsets, there is carry interest rate risk from the different value dates. This is not captured by net open position (NOP) calculations, which have traditionally been used for most FX prime brokerage margin frameworks.

If you are accurate in the way that you assess risk and have a transparent dialogue with the client, that gives you a stable framework, and clients recognise that
Vincent Bonamy

These developments mean HSBC has had to adapt its risk management and margin framework, and thereby ensure that the business both understands and appropriately margins the resulting interest rate risk.

During the first quarter, the bank rolled out a new tool that assesses interest rate sensitivity metrics by currency pair and tenor when setting out the margin framework for a client. The tool monitors the DV01 risk of a client’s positions and stress tests them. Custom interest rate scenario events have been added to its framework when setting initial margin parameters to ensure the bank receives the appropriate amount of collateral.

Laman says: “By introducing interest rates sensitivity metrics, alongside specific stress scenarios to capture curve dislocation events, we have been able to facilitate increased exposures for clients without taking on risk that might otherwise be under-margined under the standard NOP-focused framework used in the market.”

The tool has proved effective when it comes to onboarding specific long-dated strategies from large clients. One global macro fund wanted to trade a long-dated FX swap with a tenor of more than three years. Such trades can be greatly affected by changes in interest rates, and the fund would not have been sufficiently margined under the traditional NOP framework. HSBC was able to factor interest rates sensitivity metrics and agree a margin framework with the client ahead of the trade so that both sides were comfortable.

Bonamy says the tool also gives confidence to new clients as it enables them to better understand their risk profiles and how their margins are calculated: “They know how we are going to measure and assess the risk. They know exactly what the framework is, and how they can work within this framework. It gives them the full understanding on how we operate and, as such, you can design a framework that can scale with their trading strategies.”

Weighing up the options

HSBC has made significant changes to the way it manages FX options risk.

Its clientele includes some of the largest macro hedge funds, which have become more sophisticated in the way they trade options. However, the ways in which FX prime brokerages have traditionally measured the risk of options trades – for example, by including the delta of the option in the NOP limit calculation – have become outdated.

The bank has worked with clients on factoring vega limits, a model used by most options trading desks to measure sensitivity to implied volatility. By being able to monitor and control this risk more effectively, HSBC has been able to capture increased growth, with clients trading exotic FX options without creating additional risk management issues.

“NOP limits may have worked 15 years ago, but as clients are getting more and more sophisticated and their portfolios are becoming more diverse as well, we’ve had to adapt so that our risk methodology reflects the complexities within a portfolio,” says Laman.

She says HSBC shares this data with clients so they too can see the risk components of their FX options trades within their portfolio.

We’ve had to adapt so that our risk methodology reflects the complexities within a portfolio
Gemma Laman

In addition, the bank has given clients self-service capabilities over how their FX options trades are compressed. This year, it launched an in-house compression app within its FXPB portal that enables clients to proactively view and run their own compression opportunities. Once executed, the trade cancellations and booking process are automated and can be plugged directly into the client’s risk system to minimise any manual touchpoints.

This gives clients greater control on reducing their gross notional options positions, which have become costly as a result of the uncleared margin rules. Being able to remove FX options from the balance sheet also allows clients to optimise executing broker lines and eliminate pin risk from boxed options positions.

Since the introduction of the new functionality, total FX options compressed by HSBC have increased by $100 billion notional year-on-year.

“A lot of our big clients are utilising these features on a weekly basis to keep a very operationally efficient book,” says Laman.

Bonamy adds that the new compression feature is a prime example of how HSBC is constantly creating new solutions with clients to meet specific and bespoke needs.

“In terms of products, it’s about having a very symbiotic relationship with the client,” he says. “We have the pleasure and the chance to have some of the largest clients on [Wall Street], and we are co-creating and improving HSBC’s FXPB for the sake of the industry.”

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