Liquidity pools prove key

Inter-dealer brokers

At first glance, the aggregate results from this year’s Risk inter-dealer rankings threw up few surprises. UK-based Icap dominated vanilla interest rate swaps, US broker GFI was the leader in credit derivatives and French/UK venture TFS-Icap won overall in cross-currency products. The equity derivatives market continued to prove more diverse and therefore most open to competition, with GFI, TFS, the UK’s Prebon, Trio and Sunrise all performing well.

While the overall rankings do not appear to point to any seismic shift in the competitive landscape, there is evidence of some important changes when honing in on specific categories. This indicates that, with a number of notable exceptions, the large international brokers are extending their businesses at the expense of small to medium-sized institutions.

Notable examples include the declining power of France’s Tradition in the Japanese rates market at a time when the interest rate curve in Japan finally broke out of its flat shape witnessed during the past decade, the dwindling strength of Trio/Martin Brokers in currency products and Link’s decline in equity products.

In terms of inter-dealer customer satisfaction, Icap ranked number one for the largest over-the-counter derivatives category, interest rate products. The UK inter-dealer broker topped short- to long-term swaps, caps, floors, swaptions, exotics, OIS, repos and forward rate agreements – with 30 first-placed votes. But Prebon was not far behind, with 28 top places, while Tullett notched up 14 firsts. Cantor Fitgerald was the other broker to score highly, with 11 pole positions for the US inter-dealer broker (see table).

Future challenge

This may be set for change. UK equities boutique Collins Stewart is poised to acquire Prebon Yamane later this year for a reputed £135 million. And the combination of Prebon and Tullett – which Collins Stewart bought for £251 million in 2003 – will shake up the market, creating a major challenge to Icap’s dominance in interest rate derivatives.

In a July research report, Credit Suisse First Boston said it believes Icap holds a 40% share of the swaps market, with Tullett holding 20% and Prebon 10% – or 30% combined. Tullett holds a major role in the medium- to long-term interest rate derivatives market and Prebon is stronger in shorter-dated contracts.

Risk’s inter-dealer rankings indicate a combined Tullett-Prebon looks set to become the dominant broking force for interest rate derivatives products in the United States and Tokyo, and challenge Icap in its traditionally strong sterling and euro swaps businesses. Tullett and Prebon were second and third, respectively, in euro, sterling and Swiss franc short-dated swaps – Icap came first in all categories.

Tullett also took first place in short-dated yen swaps ahead of last year’s winner Tradition. Prebon, meanwhile, topped yen caps and floors, again beating last year’s winner Tradition. In fact, Tradition was a notable loser in the Japanese yen market – it also ceded its 2003 lead in long-dated swaps to Icap, which defended its first-place position last year in medium-maturity yen-denominated swaps.

Tullett and Prebon also appear set to dominate the smaller Australian market and may take over from this year’s winner, Continental Capital Markets, in emerging markets rate products in Europe, while also topping Icap and Cantor Fitzgerald in emerging Asian markets.

But aggregating results is probably an overstatement of the power of the two brokers once combined. Although Collins Stewart officially says the two operations will be run separately, shareholders are likely to press management on the matter. Collins Stewart has already stated it expects an aggregate revenue loss of between 10% and 15% once the two operations come under the same parent, so it is likely that costs will need to be slashed by more than that amount to improve overall margins. This means the combined operation in the short term is unlikely to prove as strong as if the two operations were run separately.

Cantor Fitzgerald, meanwhile, performed strongly in exotic rates products, overtaking Icap in four categories – US dollar constant maturity swaps, euro Bermudan and American options, quantos and volatility/variance swaps, and Eurobrokers in euro-denominated constant maturity swaps. It picked up first places in seven out of the eight categories, only losing out to Icap in US dollar-denominated Bermudan/American options.


There was only one real winner in the vanilla currency options category – TFS-Icap. The inter-dealer broker secured 14 first-place positions, or 67% of all number one positions voted by dealers for currency options.

The 2000 tie-up between TFS and Icap for currency options has proven highly successful, and the venture gained another strategic asset in 2002 by buying electronic trading platform Volbroker, established by a consortium of banks including Citigroup, Deutsche Bank, Goldman Sachs, JP Morgan Chase, Royal Bank of Scotland and UBS.

The move not only gives TFS-Icap a strong electronic platform to offer hybrid broking services, it has also helped to boost flows from Volbroker’s original backers, says TFS New York-based co-chief executive David Pinchin. This may have helped TFS-Icap to overhaul rivals Cantor Fitzgerald in US dollar/yen options and GFI for the crown in US dollar/Norwegian krone and US dollar/South African rand options this year. TFS-Icap also beats Tullett in euro/sterling currency options.

Icap, meanwhile, took 11 first places, or 73% of the total, for currency swaps. It notably beat Tullett in US dollar/yen currency swaps, US dollar/Swiss franc currency swaps, US dollar/Canadian dollar currency swaps, US dollar/Swedish krona currency swaps, US dollar/Danish krone currency swaps and US dollar/Norwegian krone currency swaps.

Both Cantor Fitzgerald and GFI secured a high number of second and third places for currency options, and Cantor Fitzgerald, along with Tullett, posted a strong number of top three positions for currency swaps.

In currency forwards, the biggest loser was Trio’s Martin Brokers unit, which did not feature in the top three for any categories this year – in 2003 Martin Brokers was first in US dollar/euro, US dollar/sterling US dollar/Swedish krona and US dollar/emerging markets Asia. Again, Icap held the most first-placed positions, with nine, compared with four first places for Tullett and five for Prebon. But a combined Tullett-Prebon is likely to prove a greater challenge to Icap next time around.

As proved the case for interest rate products, Cantor Fitzgerald proved strong in the exotics area, notching up wins that included the binary/digital, hybrids, long-dated and average rate instrument categories. Tullett, soon-to-be-floated GFI and TFS-Icap were also highly rated, although TFS-Icap’s three wins this year versus eight in 2003 meant the broker has lost its virtual domination of exotics.

Fragmented equities

GFI also put in a strong performance in equity derivatives, although this was the most highly fragmented of all categories. The credit derivatives stalwart notched up 10 first places in the individual stock options and index options categories, ahead of Prebon, which secured seven first places, and Trio, which took two.

GFI was voted the best broker in four single-stock options categories and was also ranked number one for DJ Eurostoxx 50, FTSE 100, SMI and DJ Global Titans index options. While GFI is in a ‘quiet period’ ahead of a planned initial public offering in the next couple of months, the broker significantly boosted its headcount in equity derivatives, particularly in the US in the past eight months, for example announcing 10 new hires in New York back in March.

But Prebon also proved strong in the vanilla OTC stock options market, taking top position in the telecoms, technology, media, financial institutions and autos categories in the United States.

Coverage for individual stock options in Europe was more divided, with Trio along with Prebon and GFI all scoring highly.

GFI, however, featured virtually nowhere in the exotics categories, taking just a single third-place for OTC basket options (stock baskets). By contrast, TFS secured five first positions for exotic equities, beating 2003 winner Link in the OTC basket options and ladder/look-back categories and last year’s joint winners UK-based Link and Prebon in the binary/digital and barrier segments.

Link’s relatively poor performance in the survey was compounded when Sunrise stripped it of first place in the burgeoning variance/volatility swaps business, although it held its first position for quoting cliquets. Sunrise also won the OTC basket options (index baskets) category and shared the honours with TFS as the best broker for OTC basket options (stock baskets). Link chief executive Charles Davies expressed surprise at the results, saying the brokerage had increased its flow and structured equity derivatives activities during the past 12 months.

GFI dominated the credit derivatives market. It was first in 13 out of 18 categories and was placed second four. The endorsement of GFI’s strength across the entire credit derivatives market appears impressive, particularly as management attention has lingered on the company’s impending initial public offering.

GFI was the best broker for investment grade US and European corporate default swaps, investment-grade sovereigns, high yield Europe, Latin American and European emerging markets, basket default swaps, credit spread options, hybrid structures, static portfolio swaps, synthetic CDOs, and equity/mezzanine and junior/senior bespoke single-tranche synthetics.

For a broker that has been relatively quiet about its strategic plans in the burgeoning credit derivatives market, Icap performed strongly, scoring five first places. By contrast, Creditex picked up only one win, the same as Eurobrokers, a unit of US financial services company Maxcor.

New York start-up Creditex only scored an additional second and third place, albeit in the important investment grade US and investment grade Europe sections. The private US company, which started rolling out electronic trading services to clients from the first quarter – it offers indexes and investment grade Europe to-date – has faced strong competition due to fee-cutting by rivals in the past 12 months. And most recently GFI moved into the electronic trading of credit default swaps by launching an electronic trading service for credit default swaps on European financials in August.

But Creditex chief executive, Sunil Hirani, was happy with the results. “The electronic platform didn’t really kick in until April this year and we didn’t really have a presence in indexes even six months ago. So this is a great result,” says Hirani. “We believe we have the lowest marginal cost in the industry and are happy to pass this on to our customers.”

While the major brokers appear to have consolidated their leads in the inter-dealer rankings this year, business still seems viable for smaller participants. Indeed, Hirani plans to offer an electronic service for European sovereigns and European emerging markets in the next couple of months.

Click here to view overall results

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