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Inter-dealer rankings 2004

Don’t be fooled into thinking there’s only a handful of banks that count in the global derivatives markets – there’s at least a couple of handfuls.

While the number of firms aspiring to be major providers of liquidity and product in risk management is less than it was five years ago, those firms which still have aspirations to the higher echelons of the derivatives industry are making some inroads into the apparently unassailable positions of the global powerhouses.

As the results of Risk’s 2004 inter-dealer rankings demonstrate, those powerhourses – notably JP Morgan, UBS and Deutsche Bank – still dominate (see ‘Gold medal’ table and overall results).

But in the highly competitive and evolving inter-dealer markets, a number of firms are mounting a serious challenge. These include the UK-based banks, Barclays Capital and Royal Bank of Scotland, which post an impressive series of results across interest rates, currencies, equities and credit. Other banks are expanding their capabilities, notably French firm SG CIB into areas such as rates and credit. And some are seeing returns on specific investments, such as Calyon in foreign exchange and Dresdner Kleinwort Wasserstein (DrKW) in structured credit.

Of course, most banks would say their perception among clients – such as corporates and asset managers – are of primary importance.

Evolving market

But this ignores the evolving nature of what is traditionally classed as the inter-dealer market. The number of true ‘peers’ that the leading banks have – those that are real providers of liquidity – has shrunk. That leaves a huge number of financial institutions that are now regarded more as important clients of the major banks than as competitors.

Ashley Bacon, head of interest rate trading for Europe at JP Morgan, says that in interest rates at least the concept of the inter-dealer market has seen fundamental change. “We look at banks and ask how many competitors do we really have? The answer is no more than a dozen. At JP Morgan we have a group that directly covers financial institutions for interest rate derivatives. A lot of these are now fully fledged clients.”

It’s a similar story for currency derivatives. As Jim Turley, global head of foreign exchange and commodities at Deutsche Bank, says: “There’s been a change of focus from competition to co-operation. Banks are teaming up where there is little or no overlap at the end-user level. There are a lot of bilateral partnerships that help to satisfy the market’s need for greater volume and liquidity.”

Turley continues: “The way for a bank such as Deutsche to stay ahead is to be the ultimate liquidity provider. The small are getting smarter, and I want them to be my partner and my client.”

For the major suppliers of liquidity, the commonality is a huge infrastructure, and therefore a high-cost base – and the only way to make that pay is market share.

As Andrew Kellner, global head of foreign exchange, funds and commodities at Calyon, says: “Clearly there is some concern that, through various mergers, there may be too few providers of liquidity. No-one wants the top three banks to provide 80% of liquidity – but it’s interesting that over the past few years the market share of the top three hasn’t changed, it’s the share of the top 15 that’s gone up dramatically.”

What’s happening, says Kellner, is that smaller banks are now recognising that a certain critical mass is needed to be successful in the broader market: “They’re saying let the guys with the capacity, skill sets, technology and modelling have the inter-dealer market, we’ll focus our more limited resources on end-user clients.”

And as Kellner’s colleague Derek Sammann, Calyon’s global head of FX options confirms: “A much higher percentage of market participants are now simply price takers. The call-list of firms who will make prices is a lot shorter than it was a few years ago.”

Competitive FX

That said, competition among those price-makers is more intense in currency derivatives than in any other asset class. Take the overall currency swaps ranking as an example. Just 1.5% of votes separate top-ranked Deutsche Bank from fifth-placed Calyon.

Deutsche’s strategy in foreign exchange takes its lead from a famous investment strategy – the barbell. At one end, says Turley, the firm seeks market share; at the other, it aggressively pursues structured business.

This fits the way the market is headed, says Turley. “The trend is for forex to be seen as an asset class. Clients want diversity in their investment and are looking at currencies and commodities as alternative investment strategies.”

The results of the inter-dealer rankings suggest Deutsche is proving highly successful in the flow business, ranking first overall in currency swaps and forwards and second in vanilla currency options, but less so in exotic currency options, where it misses the top five overall but shows well in areas such as barrier and binary/digital options.

While UBS and JP Morgan are, not surprisingly, also well represented in the currency results, other firms are challenging. For example, John McCormick, global head of sales and derivatives marketing at RBS, says that in the foreign exchange derivatives markets, the level of business the bank is executing has “stepped up two notches”. RBS ranks in the top five overall in vanilla currency options, currency forwards and exotic currency options.

According to Peter Nielsen, global head of FX derivatives, the firm decided to invest in its market-making abilities while other banks looked to move away from the more traditional side of the forex business.

“When the forex market came back into focus we found ourselves well-placed to benefit, because we had the infrastructure to capture flow and also the technology to provide more risk-managed solutions to clients,” says Nielsen. He estimates that the firm has been capturing as much as 30% of the inter-broker FX derivatives market during 2004, thanks to the speed and transparency of pricing its systems can provide. The next aim is to secure a similarly strong position in the spot FX markets.

The currency derivatives markets have yet another firm pushing for market share in Calyon – the fully integrated, and now rebranded, investment bank of the merged Credit Agricole Indosuez and Credit Lyonnais. The French bank scores notable successes in flow sectors such as vanilla currency options and currency swaps, where it ranks in the top five firms overall.

“We had begun to push our FX options business at Credit Agricole Indosuez prior to the merger as a foundation for building a presence in the derivatives and foreign exchange markets,” says Calyon’s Kellner. “And we wanted a high profile in the inter-bank market as these are some of the most difficult institutions to build a presence with, and it would demonstrate our capacity to potential clients.”

Kellner says the merger brought immediate synergies: “We’ve quickly been able to leverage CAI’s expertise in FX options with Credit Lyonnais’ strong client bases in North America and Asia ex-Japan.”

Turley says the fierce competitive pressures to be the number-one liquidity provider in currency derivatives will continue, and that end-user interest in forex as an asset class should grow – with one caveat: “The forex market will play off the equity and interest rate environments. How currency derivatives are used depends on how attractive these other environments are. But there’s a much greater aversion to putting everything ‘on black’, and that should be good for continued growth in FX.”

Exotic vs flow

It is difficult for a firm to build an exotics platform without having the back-up of a highly liquid and successful flow business. But the degree of difficulty depends on the market.

Take the example of RBS’s interest rate and currency businesses. RBS has similar standing, according to the inter-dealer rankings at least, in the vanilla sectors of both asset classes. But while it has struggled to build a presence in the exotics interest rates arena, it has far more success in exotic currency options, where it ranks third overall and particularly strongly in categories such as barrier and binary/digital options.

McCormick explains: “The style of trading forex options is very different to interest rate options. In rates, to have an exotic capability you must already have a major bond and swap operation. We have tended to focus on the major currency sectors where you need a critical mass. But the client base in forex is much broader, and the freedom to enter is much greater.”

Some firms have managed to achieve success in exotic forex and interest rates without much flow business – notably Goldman Sachs. But some bankers say this is not a sustainable position in the longer term. “When you de-engineer structured business, it gives you the opportunity to provide a lot of flow to the broader community,” says McCormick at RBS.

Bacon confirms that in rates it is vital to have both the flow and the exotic business, and that the end-user and inter-dealer markets also go hand-in-hand. “Each feeds the other. If an end-user drops risk in the market, you can’t just be in the end-user market, you have to be in the inter-dealer as well. And you need vanilla swaps as well as exotics. You must have the delta hedge. It is vital to have the whole picture.”

Turley says that in forex at least, it’s not critical to have a major share of flow to be successful in the structured side of the business, and vice versa. But it is the way to be most profitable. “We would not be optimising our global relationships if we did not have the intellectual firepower to go with our market share. The two go hand in hand. Our market share gives us data, which gives us an insight into the market that we can then leverage into products for our clients.”

Rates diversity

Dealers say the interest rate market has been quieter in the past few months than at any time in the past two years. That is related to a lack of opportunities in the market – and the weaker returns being posted by hedge funds is a good barometer of this.

Bacon at JP Morgan – the firm that once again dominates Risk’s inter-dealer rankings in interest rate derivatives, winning five of nine overall categories – says there has been no structural change, and that as much capital is committed to the market as ever. But, he notes: “Hedge funds and banks are looking at ways to diversify risk. Everyone is interested in the new strategy, the next idea, which is not correlated with current strategy. Sitting there with five ways to be short is not the thing to do.”

But sitting there with, they hope, several ways to break JP Morgan’s stranglehold on the interest rate markets are a number of firms, such as RBS.

“We’ve been trying to move the business forward year-on-year since 2001,” says Ian Gaskell, the bank’s global head of rates. “Our aim is to dominate the sterling curve, but we’re also pleased to see our broader strengths being recognised in euros, US dollars, Scandinavian currencies and the yen.”

Gaskell believes the biggest change for RBS has been in the US, where it has been able to combine the derivatives opposition of Greenwich (which it acquired through its takeover of UK clearer National Westminster Bank) and RBS’s existing capabilities in New York. “Our aim is to provide 24-hour liquidity in good size, and to do that you have to be joined up as an organisation,” he says.

According to his colleague McCormick, the approach is already bearing fruit. “Research suggests that 90% of flow business in the US comes from the institutional community, and we are achieving much larger flows with a wider variety of clients, including real-money managers, mortgage servicers, insurance companies and pension funds,” he says.

RBS’s traditional strengths in short-dated swaps and forward rate agreements are apparent in the rankings results, where they rate in the top five across currencies. The aim now is to extend the firm’s strength into longer-dated interest rate swaps, in the two- to 10-year areas. The next step in the global platform will be to boost RBS’s US dollar options capabilities.

Barclays Capital was a clear winner of the inflation swaps category which Jerry del Missier, head of rates and regional head for Europe, puts down to its long-standing dedication to the market. “We are committed on a global basis to the inflation market, both in cash and derivatives,” he says. “The market has gone in and out of favour but we’ve consistently been there since the beginning, providing education and liquidity to the market. It is nice to see that recognised by the inter-dealer community.”

Barclays is also committed to becoming a stronger presence in the general interest rate derivatives market. “In euros and sterling, we want to be the number one choice for customers,” says del Missier. In dollars, he admits, it is harder to break the hold of the incumbent domestic US banks, although the launch of a dollar BARX trading platform has led to a significant increase in dollar accounts.


Bacon is aware of the challenges JP Morgan faces in keeping its market-leading position. “In some ways our dollar presence is self-sustaining – the more business you do, the keener the prices you can offer,” he says. “But you constantly have to battle and re-invent, because your competitors are always changing. There are a number of second-tier banks pushing for market share. But at JP Morgan we have a concentration of the best dealers and the best information flow, plus the strength of our client relationships.”

SG, the corporate and investment banking arm of French firm Société Générale, has long been regarded as one of the leading houses in equity derivatives, and its performance in the 2004 inter-dealer rankings confirms this. The bank scoops four out of five overall categories, and 23 out of 36 sub-categories.

But it’s interesting to see the firm also picking up plaudits from its peers in interest rates and currencies, as well as structured credit products.

In rates, SG has pushed hard in the main flow areas such as options, swaps, caps and floors, says Frederic Desclaux, SG’s global head of sales for fixed income and derivatives. “As bid/offer spreads have eroded on liquid products, you have to compensate through volume. The multi-product story is not necessarily the best story,” he says.

This focus, which Desclaux says began about four years ago, has a natural home in the inter-bank market, where “the traditional type of service that succeeded was execution. However, as we became more specialised, adding relative value or volatility ideas to speed and price, we were able to service a much wider client base, deriving much larger volumes.”

JP Morgan’s focus remains on the major currencies and the core products.

As well as looking to grow its inflation-linked business – where the firm has co-opted an inflation bond trader, and vanilla inflation swaps trader, an exotic inflation trader and desk analyst to sit together on the same desk – Bacon says JP Morgan wants a bigger slice of the action in the government bond market.

“In the past few months bond asset swap spreads have been very stable. We can do better by establishing a stronger linkage between bonds and swaps, and having a government bond business commensurate with the size of our swaps arm, particularly at the long end. But you can’t link the two completely – you still need specialists.”

Bacon says JP Morgan has been leveraging its growing expertise in these areas to structure trades for its financial institutions clients. For example, it has put together a trade where the client receives the 10-year minus the two-year constant maturity swap (CMS) rate plus inflation, with the coupon floored at 0%.

This product provides the client with two inversely correlated payments. In a normal market environment, the 10-year CMS rate should be higher than the two-year. If it is not, a higher two-year rate suggests a macro-economic climate where inflation is higher, so the structure still has a good chance to pay out. These, together with products such as callable CMS swaps, have become more common in recent months.

Credit crunch

In credit derivatives, vanilla default swaps are dominated by the firms that would be expected: JP Morgan, Deutsche Bank, Credit Suisse First Boston, Morgan Stanley and UBS make up the one-to-five.

But in structured credit products there are some potential surprises. Vince Balducci, head of credit derivatives at Barclays Capital, suggests his firm’s better performance in structured credit derivatives – where it ranks second overall behind JP Morgan – over vanilla products is down to the nature of the markets.

“The greater improvement in structured credit products was expected as the market is less mature and therefore more open to new players with good ideas,” he says. For example, synthetic CDOs were a specific focus over the past two years. “We understood the risks and opportunities inherent in synthetic CDOs. Even though the market has outperformed even our expectations, we knew bespoke CDOs would be well received by investors,” Balducci says.

Barclays Capital is not the only firm to reap rewards from synthetic CDOs. Less than three years ago, Dresdner Kleinwort Wasserstein had little or no presence in the credit derivatives market. So its standing in the inter-dealer community – where it ranks in the top five overall for structured credit products, and in the top two in categories such as basket default swaps, credit-linked notes, whole capital structure synthetic CDOs and static portfolio swaps – indicates a rapid ascent.

As Matteo Mazzocchi, global head of credit derivatives and securitisation at DrKW, admits it has been an interesting period to try to launch and grow a structured credit business. “In 2002 we had huge volatility, in 2003 a sustained rally, and 2004 has been the year of relative stability,” he says.

It’s this stability that Mazzocchi believes has played to his firm’s strengths. “Clients are looking to increase returns in a stable market,” he says. “Because at Dresdner we focus on derivatives we are well placed to give clients risk transformation ideas.”

Mazzocchi says it has been important not just to focus on innovative structuring, but realistic structuring as well. “Over the past few months there have been a number of trades that dealers have promoted as a good idea, and which have their merits, but which haven’t caught on with clients, such as constant maturity CDOs,” he says. “You have to recognise that certain people are still feeling their way into this market, and that a lot of analytical support is required to go beyond a certain level of complexity.”

Mazzocchi says his firm puts a lot of emphasis on risk analysis in before- and after-sales support. “The structure you sell must be robust,” he says. “We’re not of the ‘sell as much as you can’ school.”

BarCap’s Balducci says the development of an underlying index for the credit market – first the creation of Trac-X and iBoxx, and then their merger – has provided greater fuel to the bespoke market: “Sometimes an underlying index can cannibalise bespoke products, but that’s not been the case in credit derivatives.”

Balducci says BarCap will seek to continue to build its structured credit business. “We see opportunities in tranched index options and other variants of tranched products, recovery rate swaps, also constant maturity type products,” he says.

SG’s aim in the credit markets – where it ranks fifth for structured products overall – is to demonstrate that there is still room for a bank to be a profitable player in its chosen areas. “You must try to get the most diversified and appropriate client base for a given product, rather than a good client base across all products and sectors,” says Desclaux. “If I say I want SG to be as big as JP Morgan or Deutsche Bank across the credit markets, I am not credible. But I can be credible if I say we want to be the number-one firm in bespoke single-tranche CDOs.”

DrKW is moving strongly into the hybrid credit business, where it ranks third in Risk’s poll.

“We’re hopeful that hybrids can become a significant contributor to our revenues,” says Mazzocchi. He also says the firm will continue to have a strong appetite for risk: “We are prepared to warehouse the risks while bringing transactions to the market and to sell any inventory that is left on the book down the line.”

Meanwhile, RBS’s McCormick sees credit as one of the highest growth areas for the next decade. “Given our ambition, our credit rating, the size of our balance sheet and our willingness to use these products ourselves to manage risk and pass on opportunities to our clients, there is an inexorable move towards having a credit business that matches our strengths in interest rates and currencies over the next three to five years,” he says.

That leaves equity derivatives as the potential sticking point to RBS challenging the major global banks as a derivatives powerhouse across the asset classes. McCormick says: “We want to be in the end-user equity derivatives business, for structured notes and corporate finance; for economic hedging; and for our own retail structured products. It’s a very focused, bespoke model that we believe can be highly successful.”

The performance of Barclays Capital in this regard should give RBS hope. One of the major surprises – or success stories, depending on your viewpoint – of the 2004 inter-dealer rankings is the group’s strong performance in equity derivatives. The firm won numerous categories in equity index options, and came out ranked first overall in exotic equity products.

The surprise to some, and the success, is that BarCap has succeeded in equity derivatives despite having no presence whatsoever in the cash equities market.

Maurits Schouten, head of equity-linked products at BarCap, says the firm has been aggressively building its profile in both the flow and structured markets over the past 18 months.

“As a firm we are very comfortable dealing with complex products and risks,” says Schouten. “We’ve pushed products such as variance swaps and correlation swaps to hedge funds, which is a great off-set for our own retail book.”

While Barclays Capital has ambitions to be a top-five player in equity derivatives in Europe, Schouten says the firm will continue to pick its opportunities carefully. For example, to gain a presence in the US, it has initially focused on index options (to some effect, ranking first in the Nasdaq 100 and S&P 500 categories) but plans to build its US single-stock capabilities over the next year.

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