Anatomy of a merger

Dealer profile

John Anderson is now finally able to sit down at his desk in New York without the thought of a regular journey to Chicago weighing on his mind. In recent months, Anderson – head of foreign exchange trading at JP Morgan – has had to split his time between the two cities as Bank One winds down its currency trading operations in Chicago.

Anderson says that there he will not make any immediate significant changes to his team’s structure or activity. “JP Morgan’s foreign exchange platform is already robust and impressive. That said, we can and will get better,” he says.

Until a month ago, Anderson was head of interest rate derivatives and foreign exchange trading at Bank One in Chicago. Nearly all this group’s sales staff will stay on at the newly merged entity in Chicago. Six out of the 10 fixed-income derivatives traders are moving to New York.

Things are less stable on the currency trading side. Only a single trader from the 20-strong foreign exchange team is staying with the firm and making the move to Manhattan. “More than half the [currency] traders were offered roles, but most declined for personal reasons,” Anderson says. Certainly for currency spot traders – who tend to receive modest salaries in comparison with their derivatives trading colleagues – it would be hard to maintain their standard of living in New York.

Anderson’s role in rejuvenating Bank One’s currency derivatives trading during the past few years was pivotal. A source familiar with their operations told Risk that its currency options volumes have sextupled since Anderson took charge in early 2002, while profits have increased by more than 50% during the last year.

When Anderson began managing the group, it only had one options trader. His decision to put more emphasis on derivatives was not without controversy – there was some historical institutional baggage to negotiate. In an earlier incarnation (as First Chicago), the firm was one of the largest foreign exchange banks in the market during the mid- to late 1980s.

So how was it that a firm with the largest currency options portfolio in the world evolved from a firm whose activity in the currency markets gave it a market share that barely placed it in the world’s top 50 at the start of 2002? The answer is mergers.

In 1995, First Chicago merged with the National Bank of Detroit. Then there was another merger between this entity and Bank One in 1998.The lack of capital markets activity at the two latter institutions led to a progressive market-share decline in the currency markets.

There was virtually no high-volume foreign exchange activity at the firm and with that, little trading activity, since it was focusing on a regional client base. At First Chicago, capital markets accounted for around one fifth of overall revenue streams. At Bank One, the proportion eventually fell to around a few percent.

The seeds for this decline were sown in the early 1990s, when senior management decided that risk-taking in general, and derivatives trading in particular, did not fit into a conservative business model. It was decided that the middle-market bank should focus on servicing its corporate clients.

Almost overnight, risk-taking was removed from the business mix. The trading head count was slashed. Although Bank One still had around 40 traders by 2002, their risk profile was such that many were de facto executors – their role being to facilitate business flow coming from the sales desk. “Removing risk-taking from the equation helped our bottom line in the near term,” says Anderson. “The problem was that it wasn’t necessarily an optimal decision in terms of benefiting our future growth prospects,” he adds.

So Bank One had gone from being a trading-dominated shop to one where risk-taking was not tolerated. When he began his new role in 2002, Anderson realised there had to be a happy medium. “Without some kind of risk appetite, we weren’t going to be taken seriously by financial institutions and other sophisticated players – we needed those in our client base too,” he says. Bank One hired currency options traders in Chicago and London during 2003.

Anderson’s experience undoubtedly made him an attractive candidate for leading currency trading. The fact that he has worked at Bank One – since before it was Bank One, so to speak – also helps assuage those staff worried that the behemoth-like trading group at JP Morgan will crush under foot the qualities and strengths of the Chicago firm’s approach.

“Pre-merger, both firms had strengths, as well as areas to improve. As a combined entity, we are adopting the best practices of both,” Anderson says.

So, for example, whereas Bank One was extremely skilled in the management of its plain vanilla currency options portfolio, JP Morgan had the edge when it comes to exotics.

In his new role, Anderson says he will continue to push the agenda pinpointed by David Puth – head of the global commodities and currencies group at JP Morgan – several years ago. That is, to blur, as a number of firms have, the lines between traditional foreign exchange and other capital markets products. Higher-margin products – such as those that link currency risk with derivatives in other asset classes, or basket or correlation trades – are a focus.

This position makes sense when put in the context of JP Morgan’s performance in Risk’s annual inter-dealer rankings. While the firm is clearly a top player in interest rate and credit derivatives, its performance in foreign exchange is more patchy – although it ranks strongly in exotic currency categories such as barrier options and hybrids (see Inter-dealer rankings beginning on page 46).

In recent months, it has been decided that market share must also be sought. “Bid-offer spreads are very tight, and they will probably become even narrower,” says Anderson. “Even so, it’s important to continue to seek volume in order to serve clients and develop relationships, which can lead to structured transactions,” he adds.

Anderson says merging the risk management of the two legacy portfolios has been more straightforward than many might expect. Bank One’s interest rate options portfolio, for example, was small in comparison to JP Morgan’s. One major counterparty estimates that the Chicago-based firm probably has significantly less than 100 options trades booked – unsurprising given it only began staffing up its options desk around 18 months ago.

“Merging the Bank One portfolio in was both easy and difficult. It was big enough to be a lot of work, even for all the plain vanilla stuff,” says Anderson. “The relatively difficult parts arose with the structured transactions, including a couple of interesting trades, the like of which JP Morgan – despite having the expertise – had not executed,” he adds.

An example of the kind of trade that Anderson is talking about was a basket credit derivative, linked to an interest rate basis swap, This was then quantoed; that is, a payout specified in a particular currency or interest rate was then swapped into another currency, or rate. As a smaller shop, Bank One was able to get different groups and technologies to work together seamlessly, Anderson says.

All Bank One’s trading book risk has now been transferred to JP Morgan. This was achieved via the creation of a mirror portfolio: back-to-back trades between Bank One and JP Morgan for each of the former’s existing transaction were executed. Counterparties will eventually have their trades reassigned to JP Morgan. Like most dealers, Bank One required collateralisation for more complex trades.

Anderson knows the trauma that can befall firms that fail to keep a careful eye on their exotics book. In the early to mid-1990s, First Chicago, like many firms, came unstuck because of its positions in Bermudan options. In 1995, senior management asked Anderson – then the most profitable trader on the interest rate swaps desk – to sort out the mess. After around nine months, he had turned things around and in September 1997 he was put in charge of the options desk. Then, in 1999, he was made responsible for all derivatives trading; foreign exchange was added to his remit at the start of 2002.

Anderson says his style of management is “hands off”, but that he is also a big believer in constant discussion with traders about their profit and loss, style, and place within the wider institution.

But won’t constant analysis of results lead traders to feel constrained? He says not. “I try to stress bottom line profitability and help each trader understand how this affects their own compensation and how it’s important to the organisation,” Anderson says.

The attitude that, even if you are a big player, you still have to work harder than anyone else, is something that Jamie Dimon – president and chief operating officer and chief executive designate at JP Morgan – apparently holds dear. Traders who voice the familiar refrain, ‘Because we are JP Morgan’, when asked why a client chooses them as a counterparty might do well to check their complacency.

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