Citi reorg the final note in failed swaps clearing model

The other shoe has finally dropped for Citi’s giant swaps clearing unit.

A little over a year after the retirement of Jerome Kemp, the bank’s long-standing global head of clearing, the division is being reshaped to support Citi’s ambitions of becoming a top-tier stock trading house.  

The restructuring is the latest salvo by Fater Belbachir, a former JP Morgan and Barclays executive who was hired 18-months ago to shake up Citi’s equities business. But the reckoning for the clearing unit – which surprised many on the outside, and even some inside Citi – has been years in the making.

It has been nearly a decade since US swaps users were first required to clear their trades. For much of that time, banks have been complaining about the devastating impact of the leverage ratio on what many had hoped would be a brand-new high-turnover, high-revenue business.

Citi was the exception. At industry conferences and in the financial press, its executives made a point of banging the drum for clearing as a standalone business opportunity, openly talking of the double-digit returns the unit was making. But it was often a lone voice.

Goldman Sachs was the first to break ranks. In 2015, it imposed a 75-basis-point margin holding fee on some clearing clients – effectively a fourfold increase in the cost of clearing a swap with the Wall Street titan, one client claimed – as the stark implications of its additive effect on a bank’s leverage footprint become horribly clear.

The move marked an effective retrenchment by the swaps and futures execution giant, sending the message that clearing was now viewed as a value-add to blue-chip clients that trade with the bank – not a money-spinner in itself. Many banks followed suit, booting out clients and repricing existing agreements. In the months that followed, several shut up shop altogether.

It’s taken a full six years for Citi to signal its own retrenchment, with its clearing unit now sucked into the orbit of the bank’s plans to bolster its equities business, and the lauded management team that built its enviable market share departing in acrimony.

Citi proudly made a name for itself as an activist futures commission merchant in the interim, lobbying on behalf of the industry (but largely for itself) for changes to the leverage ratio, new counterparty credit risk rules, and, most contentiously, clearing house margin policies. It won many of those battles – but in the end, seemingly not by enough to sufficiently bolster returns.

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The latter, perhaps more than any other factor, has severely undermined banks’ ability to make a go of clearing as a profitable business. Citi was apoplectic at the size of intraday margin calls issued by LCH, the market’s largest swaps clearer, in the wake of the Brexit vote – calls that reached a similar magnitude after the collapse in Group of 10 rates at the peak of the coronavirus last year.

The funding drag of meeting those calls on behalf of clients intraday “isn’t really reflected in the return on capital”, says one industry observer: “They don’t basically say: ‘OK, we have to set aside between $6 billion and $12 billion in case, you know, Brexit or Covid happens.’”

Of Citi’s shift in strategy, he concludes: “One would not do this to a business generating double-digit returns with little counterparty risk.”

After a bruising 2020, banks everywhere are reappraising the risk and return of clearing for clients that generate little in the way of execution revenues – often “paying full freight, but not a franchisee”, as another veteran of the clearing business puts it. In other words, the standalone fees many clients pay for clearing are often insufficient to compensate for the counterparty and funding risks the bank takes.

Citi has done the right thing in adjusting its strategy to this reality, the first observer adds, arguing it is final proof it’s not possible to run clearing as a standalone business: “It has to be an ancillary business, a support business – it can’t stand on its own under the current market structure.”