Interdealer rankings 2009: Brokers

The top interdealer brokers remain largely unchanged from last year, despite the unprecedented market conditions. But a push towards central clearing and exchange trading by regulators could lead to a shake-up in the industry. By Alexander Campbell, with research by Xiao Long Chen

The collapse of Lehman Brothers last year triggered unprecedented volatility across asset classes, a blowing out of credit spreads, and the rescue of key financial institutions by governments across the globe. In response to the crisis, regulators are slowly working their way through an impressive agenda of regulatory fine-tuning, covering everything from central clearing of over-the-counter derivatives to higher regulatory capital charges. But despite all this change over the past 12 months, some things remain constant. And the top brokers in this year's Risk interdealer rankings remain broadly unchanged from 2008.

London-based Icap led the interest rate sector, as it has done every year since 2006, winning 24 out of the 53 product categories (see table). Its closest rivals, Tullett Prebon and Tradition, won 11 categories each.

The currency market remained closely contested between Tullett Prebon and Tradition-Icap. Tullett Prebon took the lead after coming second last year, winning nine out of 23 categories compared to Tradition-Icap's eight. Tradition-Icap was again the strongest in currency options, taking first place in five of the six vanilla options categories and three of the five exotics. Tullett Prebon led the swaps and forwards markets.

In equity derivatives, London-based equity specialist Sunrise took first place in 15 of the 21 product categories, once again dominating the market in which it won 19 out of 23 first places in 2008. And the credit derivatives market saw a clean sweep by New York-based GFI, which took first place in all 14 categories.

But these successes took place against the backdrop of extreme volatility and a shrinking in the size of the market. In the second half of 2008, notional outstanding volume of OTC derivatives fell 13.4% to $592 trillion, the first contraction in the market since records began, according to the Bank for International Settlements.

This decline is mirrored in the results of the brokers themselves, with many reporting reduced volumes in the last few months of 2008 and into this year. In the 12 months to July 2009, the average daily volume of currency and fixed-income products on Icap's two electronic broking platforms, EBS and BrokerTec, was $639.9 billion - sharply lower than the average of $825.5 billion for the previous 12 months. Average daily volume in July was $591.6 billion, compared with $645.9 billion in June.

Tullett Prebon also remarked on lower volumes in several product categories in its 2008 annual report, including currency options, emerging market currency forwards, interest rate options, emerging market interest rate swaps and equity derivatives. The broker identified deleveraging as a primary cause of falling volumes: "It is likely the number of counterparties in OTC markets (mainly banks), the amount of capital they devote to trading in general, and their risk appetite, will decline sharply as a result of the financial crisis."

With regulators planning to increase their scrutiny of the OTC derivatives markets, the environment could become even more challenging for brokers going forward. Supervisors in both the US and Europe have declared they will require standardised OTC contracts to be cleared by central counterparties, while non-standardised contracts will need to be reported to trade repositories. The US Treasury and European Commission have also said they would like to see a greater proportion of the derivatives market migrate to exchanges.

The credit derivatives market has been the first to move to central clearing, with a variety of platforms launching operations in the US, UK and Europe. In preparation for the start of central clearing, a number of alterations were made to standardise the credit default swaps (CDS) market, including the introduction of fixed coupons on single-name contracts, the removal of modified restructuring as a credit event in the US, and the integration of restructuring into the auction settlement process for European contracts.

Together with ongoing uncertainty over the regulatory environment, these changes have caused a drop-off in credit derivatives volumes in the interdealer market, claims Colin Heffron, president of GFI in New York. "We saw lower volumes in the first two quarters of the year - although we're now seeing some stabilisation - but that was offset by much higher cash volumes. People don't know what the outcome will be with central clearing and who will eventually regulate the market, so they are getting credit exposure through the cash market, not the derivatives market."

Slowdown

In particular, the shift to standardised fixed coupons - 100 basis points and 500bp in the US, and 25bp, 100bp, 500bp and 1,000bp in Europe - has contributed to a slowdown in the market, as participants concentrate on 'recouponing' legacy trades, says David Casterton, chief executive for Europe, Middle East and Africa at Icap in London. "Until people have gone through the necessary pain of recouponing, they're holding back from trading in the CDS market - which is understandable."

Central clearing has existed for interest rate swaps for some time through platforms such as SwapClear from London-based LCH.Clearnet, which many brokers say has aided the development of the overall market. As a result, few appear to be worried about plans to push all standardised OTC contracts through central counterparties. Nonetheless, there are concerns about other changes being introduced by regulators - in particular, their ambition to force more of the market on to exchanges.

Both dealers and brokers point out standardised exchange-traded contracts do not offer firms the flexibility to exactly offset the exposures they want to hedge - flexibility that can only be achieved through the OTC market. At the same time, the complexity of many products means they are not necessarily suited to exchange trading. "The rush to the exchanges is just not feasible in most product ranges," says Bruce Collins, deputy chairman of Tradition in London.

The move to improve levels of electronic execution, spearheaded by the Federal Reserve Bank of New York, is generally welcomed by brokers. Most have already launched electronic platforms, but many also point out electronic execution is unlikely to succeed across the full gamut of derivatives products. "A move towards more purely electronic execution is possible, but it will be difficult. Even in some forex categories there is still a voice element - a lot of products still need a hybrid approach with voice broking involved," adds Collins.

That's not to say all moves to improve levels of electronic execution and trade processing are frowned upon by brokers. In particular, the launch of trade compression platforms such as the triReduce service from Stockholm-based TriOptima have helped free up dealers' balance sheets, facilitating new trades, says Heffron of GFI: "Anything that frees up room on banks' balance sheets is good for our business."

In fact, some brokers have been embracing the changes, expanding their business into trade processing and valuation to diversify their operations. For instance, Icap announced in April the creation of a joint venture with CLS Group to provide trade aggregation services to participants in the OTC forex market. It is also involved in a consortium that made an approach to acquire LCH.Clearnet earlier this year.

Despite this, Casterton stresses brokers have, if anything, become more important over the past 12 months: "A lot of business has always been executed bilaterally between banks, not through the broker market. But in markets like these, the share of volume going through the brokers will have gone up because it's very hard to find a price bilaterally, and there are also issues like counterparty risk and validation of prices. Outside a few very large organisations, the willingness to quote a two-way price all day is not what it was, and you really have to scour the market to find someone with the opposite interest to you. We have been seeing this more or less for the past year."

Claude Amar, chief executive of Sunrise, agrees, adding much of flow during the crisis tended to consolidate around the top brokers. "We have benefited from the polarisation - customers have concentrated on the market leaders in a difficult market environment."How the poll was conducted

Risk received 1,250 valid responses from dealers and brokers to this year's interdealer survey. The responses were divided between Europe (63.2%), North America (20.8%), Asia (12.2%) and other (3.8%).

The survey covered 117 derivatives categories across interest rates, foreign exchange, credit and equity derivatives. Participants were asked to vote for their top three derivatives dealers in order of preference in derivatives categories they had traded in over the course of the year.

It is important to note this poll is not designed to reflect volumes traded in any particular market and is therefore not necessarily a direct reflection of market share - voters could base their decisions on a variety of criteria, including pricing, liquidity provision, counterparty risk, speed of execution and reliability. In that sense, this poll should be considered a reflection of how market professionals view their peers in terms of overall quality of service.

Respondents were not allowed to vote for themselves or any subsidiaries of their firms, and all responses were checked thoroughly for validity using automated and manual checks. This is a process we take very seriously, and we disqualified 306 votes this year that showed signs of suspicious voting.

The votes were weighted, with three points for a first place, two points for second and one for third. No weighing system was used for brokers, as respondents only submitted one vote. Only categories with a sufficient number of votes are included in the final poll.

The top banks are listed in terms of overall percentage of votes, as well as number of first-place wins. To decide the overall winner, Risk uses the overall percentage of votes for each bank. The survey also includes a series of overall product leaderboards, calculated by aggregating the total number of votes across individual categories. These overall results are naturally weighted, as there are more votes in the large categories (for example, US dollar and euro swaps) than the smaller, less liquid categories.

Risk interdealer rankings 2009