Fixed-income derivatives rankings - Interest rate derivatives: The rates business rated for 2008

Ronan O’Neill spoke to senior rates professionals.

In association with Total Derivatives

Interest rate derivatives: Rates - a year in the market

The interest rates business is the single-biggest revenue source in the investment banking industry. Rates revenues exceeded those of the credit business even during the credit bubble years. But now that credit revenues have collapsed – indeed have turned negative at many large banks – the rates business is all the more critical. For under-capitalized banks that over-invested in the structured credit business, the performance of their rates business is the key to survival.

When the credit crisis first hit, rates revenues held up remarkably well, supported by increased volatility, wider bid-offer spreads and the structural curve steepening that was prevalent across the industry. But in March 2008, after the Bear Stearns rescue, the market became much more challenging.

Trading conditions in rates have become increasingly illiquid, dealers have widened bid-offer spreads further and clients have become increasingly wary.

In all, 2008 has been the most challenging year for the rates business since fixed-income derivatives rose to prominence in the late 1980s.

Profitability in the rates business has not been wiped out as it has been in credit. But banks are reeling under the pressures of lower risk appetite, reduced leverage and dwindling capital.

Amidst the carnage, there are opportunities – and success stories.

Against this background, Total Derivatives, in association with Euromoney, conducted its global fixed-income derivatives rankings.

The poll is the largest and most comprehensive peer review of investment bank performance in interest rate derivatives. There were 831 individual responses to the survey, registering a total of almost 2,500 votes. Senior professionals involved in trading, sales and marketing, structuring and strategy at investment banks formed the largest group of respondents, with portfolio managers at hedge funds and traditional asset managers also taking part.

The results show that the leading market-makers with best access to two-way flows from a wide range of clients, and those that can manage risk most effectively in an extreme environment, have capitalized on the experience of 2008 to strengthen their dominance. The most prominent underperformers in this survey are the independent US investment banks: only Goldman Sachs made it into the top 10 overall, in seventh position.

The main winners

JPMorgan was the standout winner of the poll. The bank came in first overall by a significant margin and was the only bank to appear in the top three in all five global product categories. By currency, JPMorgan was first in US dollars, second in euros behind Deutsche Bank and second in yen behind MUFG.

"Investors in exotic products are well aware of the risks that such products entail, and while some areas of the structured product market have slowed, other products have taken their place" Chris Willcox, JPMorgan

He adds: "The past year has demonstrated that clients see consistent liquidity provision to be absolutely vital. A number of dealers have responded by withdrawing their liquidity from their clients and the inter-bank market. But JPMorgan believes that one of its core strengths is the ability to determine an appropriate market level and provide liquidity to the market, even in very challenging conditions."

JPMorgan sees 2008 as an opportunity to extend its franchise. "As and when the market normalizes," says Willcox, "we expect to have significantly extended our client base, market share and reputation as the top rates derivatives house."

With regard to the Bear Stearns acquisition, Willcox notes that the investment bank "had penetrated a number of markets very successfully". By incorporating Bear’s relationships into the JPMorgan franchise, the bank has "further extended our client base both in terms of sectors and geographic coverage." He adds, however, that, "the most valuable asset is the Bear Stearns talent".

Deutsche Bank, increasingly JPMorgan’s only rival for the position of leader of the global rates business, came second in this survey but dominates the euro results.

Wayne Felson, European head of rates at Deutsche, notes that the bank "has always maintained a good balance between vanilla and structured products with a focus on e-commerce and client solutions" and that this approach has worked "particularly well in this market environment". He adds that "the requirements of our clients may be quite different than before the crisis," and that the "product focus has shifted towards the more liquid spectrum".

"Market access and liquidity provision is clearly becoming much more important," he says. "Especially as several dealers pull back due to internal issues."

MUFG was voted overall number one in yen rates in the poll and was the only bank to appear in the top three in all five yen product categories.

It has been a banner year for yen rates derivatives in 2008, says Hiroyoshi Sakamoto, Tokyo-based head of rates trading at MUFG. "We had updated our risk architecture, pricing systems and analytics before the crisis hit," says Sakamoto. "MUFG is one of the firms that possesses world-class derivatives capabilities, coupled with a massive domestic franchise in Japan."

MUFG is now working to "introduce more sophisticated derivative solutions to our clients," Sakamoto notes. "Deeper pockets and larger risk appetite than the US and European investment banks will allow us to further capitalize on higher-margin derivative products."

"It takes at least a year to get an effective strategy derivatives platform up and running" Kara Lemont, BNP Paribas

BNP Paribas performed well across the survey and came out top in exotics globally, nudging JPMorgan into second place. BNP Paribas was also ranked first in euro inflation products.