Tougher regulatory requirements around capital and leverage ratios, and Volcker rules around prop trading, continue to reduce the ability and appetite of banks to provide principal based market-making activities, and warehouse risk. The more capital-intensive the product (such as inventory based corporate bonds), the less appetite banks have to provide such services.
As a consequence, there has been a reduction in levels of liquidity in some markets, resulting in increased volatility as market-makers are less able to provide immediacy risk transfer pricing and take large positions onto their books.
However, as banks step back, non-bank market-making firms are stepping up to the plate to provide those services. Which is why, back in September, I mentioned that the move by Zar Amrolia from (the Mighty) Deutsche Bank to the non-bank market maker XTX, was a sign of the times.
With that in mind, it’s interesting to read Kevin McPartland of Greenwich Associates (actually Kevin is always worth reading) interview with Paul Hamill, the new Head of FICC at Citadel Securities, talking about the impact of Dodd-Frank on swaps markets.
It’s worth noting that Paul Like Zar, has also recently switched from a Tier 1 bank, in this case UBS where he was Global Head of Fixed Income Agency Execution, to run the Fixed Income, Currencies and Commodities (FICC) business for Citadel. As Paul was running the agency business, I guess it’s no surprise to see him switching to the other side of that relationship, now as market-maker again.
By way of background, back in 2013, Ken Griffin, the CEO of Citadel commented that as a result of the introduction of Dodd-Frank rules that:
“Spreads had narrowed, there was a material reduction in counterparty credit risk, and dramatic reduction in operational risk, and from my perspective as a client, this brave new world of Dodd-Frank for ‘cleared’ derivatives has been fantastic. Fantastic”
Citadel claims it has the largest market share by number of swap trades conducted over the Bloomberg trading platform.
So much for being a client…..
Below is a short extract from the interview, which provides some insight into why Citadel decided to become a market-maker in swaps.
Question: What led Citadel Securities, the firm’s market-making arm, to enter the interest rate swaps market?
Paul Hamill: We spent a lot of time talking to investors and thinking about the problems they were facing in the swaps market. We looked at our firm’s market-making capabilities and concluded we could make the market much better for investors by offering a superior model.
Under the old market structure, trading swaps involved manual negotiation with a lot of back-and-forth between salespeople, with little transparency around price. By introducing our technological and quantitative capabilities into the market, investors now benefit from immediate execution, firm pricing and consistent liquidity in all market conditions.
Question: Are the changes in the swaps market unique or do you foresee similar market structure shifts across fixed-income products?
Paul: Potentially, and we certainly hope so. Changes to the swaps market in the U.S. demonstrate the benefit to investors when the playing field is level and all parties have impartial access to make or take pricing. It’s Citadel Securities’ view that impartial access should be applied to all markets so investors can benefit from more sources of liquidity, greater competition and the innovation that comes with it.
Question: Paul, how do you see Citadel Securities’ role evolving?
Paul: We’re going global with this business. We recently launched in Europe to provide liquidity to customers in Europe and Asia. We’re going to launch additional currencies by the end of the year, and we’re about to go live providing liquidity in U.S. Treasuries. Credit is also a natural market for us, which we will intend to enter in early 2016.
Full interview is available here