Volatility, liquidity, new technologies, Libor reform, China, operational risk … and a bit more volatility. These are the topics that come up repeatedly when you ask senior traders, risk managers and regulators about their hopes and fears.
Over the next two weeks, as part of our 30th-anniversary coverage, Risk.net will publish 10 interviews with bigwigs from the worlds of risk management, trading, market infrastructure and regulation, starting today with George Athanasopoulos of UBS – the Swiss bank’s global head of foreign exchange, rates and credit (FRC).
Other interviews include Jerome Powell, governor of the Federal Reserve Board and newly nominated successor to Fed chair, Janet Yellen; Ashley Bacon, chief risk officer at JP Morgan; and Eileen Murray, co-chief executive at Bridgewater Associates. A full list of interviewees can be found at the end of this article.
They come from diverse backgrounds, organisations and countries – a Chinese securities house, a US clearing house, an Australian bank, a Danish pension fund – but common threads emerge.
Today, UBS’s Athanasopoulos imagines a near future in which volatility surges higher and money floods out of bullish strategies and products. In this environment, to absorb the move, the market would need active fund managers and liquidity providers with the capacity to take risk. He worries these participants will be in short supply.
“I think so much money has left active investments – and also the risk capacity from banks has declined at such a pace – I’m not sure the bid will be there in the size the market will require for the fall to be shallow,” he says.
JP Morgan’s Bacon shares these concerns. He theorises that markets may in future veer between two extremes: “Perhaps we end up in a bimodal situation where in good times things are especially stable and less volatile, and in bad times they may be far more unpredictable and volatile than we have seen in the past. We haven’t experienced so much of the latter in recent years, but I do have a concern that when it inevitably comes, markets may be thinner and more volatile than we used to experience.”
Like Athanasopoulos, he says the current fashion for volatility selling could amplify this next break. Trend-following and short-term self-fulfilment is nothing new, he notes, but he agrees it “could be a bit more pronounced now than it was in the last cycle”.
If Lehman Brothers or Bear Stearns had gone under as a result of an idiosyncratic event, it wouldn’t have affected the rest of the worldNick Silitch, Prudential Financial
Nick Silitch, chief risk officer at the biggest US life insurer, Prudential Financial, argues post-crisis reform has focused on trying to make individual institutions more resilient and has failed to grasp the dangers of systemic market risk – potentially, even magnifying them.
“If Lehman Brothers or Bear Stearns had gone under as a result of an idiosyncratic event, it wouldn’t have affected the rest of the world. The fact Citi and Wachovia were going to have to take writedowns on the same assets that caused Lehman and Bear to be so deeply wounded is what made it a systemic event. The linkage for all the firms is markets,” he says.
The strength of the markets has been sapped by the retreat of well-capitalised banks, Silitch argues.
Nature abhors a vacuum, of course, and so do markets – a pullback by international banks should have created an opportunity for big regional and domestic banks to step up. Some have done so, only to find the gaps left by the big dealers are not worth filling under the new capital regime.
Following an all-out assault on regional markets, Australia’s ANZ was left unbalanced – in 2015, its Asian and institutional business was consuming more than half its group capital, forcing it into its own retreat. Client numbers have been cut from a peak of around 27,000 to roughly 8,000 today.
But the Australian bank is still expanding selectively. In Shanghai, for example, the institutional business now employs 40 people, having almost doubled in size over the past two years.
As ANZ and other institutions look at China’s expanding, liberalising markets, Chinese institutions are looking outwards – take Haitong International Securities as an example. The firm’s chief executive, Lin Yong, notes Chinese securities houses now regularly top capital markets league tables in Hong Kong, and predicts further expansion geographically and by product set.
A huge number of new currencies have launched – it has the feel of a huge bubble – but nevertheless I believe this world is here to stayMichael Spencer, Nex
Haitong already has equity research teams in London, New York, Singapore and Tokyo, as well as an India presence thanks to its acquisition of Portugal’s Banco Espirito Santo de Investimento. The plan is to expand from research into investment and trading.
But these are largely cash and light derivatives businesses, so who will fill the role once played by dealers in exotics? Denmark’s PKA is already doing so – part of a small but growing cohort of investors that has been helping dealers hedge and recycle risks they can no longer warehouse – but it’s an opportunistic player, not one the market can necessarily depend on.
“Historically, these opportunistic derivatives trades have been very profitable for PKA, so hopefully we will see the exposure growing, but it is solely a function of the attractiveness of these trades,” says Michael Nellemann Pedersen, chief investment officer at the fund in Hellerup.
This story – loosely, about changes in liquidity and market behaviour – is one of the bogeymen of the post-crisis period. Firms will only know whether they were right to worry when and if the low-volatility blanket finally lifts.
But there are newer ideas in the Risk30 interviews as well – many of them springing from the application of new technologies.
At Nex – the tech-focused firm broken out of Icap this year by its founder and chief executive, Michael Spencer – the venture capital unit has until now been focused on opportunities that are close to home, but it is now being prompted by Spencer to look at crypto-currencies.
“A huge number of new currencies have launched – it has the feel of a huge bubble – but nevertheless I believe this world is here to stay, it does solve some problems in terms of the very efficient transfer of title [and] efficient transactions,” Spencer says.
UBS is experimenting with its FRC central risk book – auto-hedging client trades with products that are cheap and reasonably well-correlated. Hedging costs are lower; basis risks somewhat higher. ANZ has added 20 data scientists to its institutional business during 2017, and one of their early insights has been to reveal new information about the behaviour of foreign exchange markets before and after certain economic data is released.
JP Morgan’s risk function has also been exploring the potential of machine learning and artificial intelligence, with Bacon seeing applications in anomaly and trend detection, as well as natural language processing. What does this mean for risk managers?
“The risk manager of the future will be someone who knows how to deploy these techniques to the maximum benefit. That’s a mindset and skillset change that will occur – starting now and increasingly so over the next three to five years,” says Bacon.
Risk30 interview series:
George Athanasopoulos, global head of foreign exchange, rates and credit, UBS
Ashley Bacon, chief risk officer, JP Morgan
Michael Bodson, president and chief executive, Depository Trust & Clearing Corporation
Eileen Murray, co-chief executive, Bridgewater Associates
Michael Nellemann Pedersen, chief investment officer, PKA
Jerome Powell, governor, Federal Reserve Board
Nick Silitch, chief risk officer, Prudential Financial
Michael Spencer, founder and chief executive officer, Nex
Mark Whelan, group executive for institutional banking, ANZ
Lin Yong, chief executive, Haitong Securities International