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| Survey results index Bond markets: The threat from rising rates |
Last month, ill-informed speculation grew to a crescendo that Antony Jenkins, the newish chief executive of Barclays, who spent his career on the retail side of the bank, would take the axe to the investment banking division. After all, UBS’s shares had been re-rated after the bank announced a wide-scale deleveraging of the investment bank, particularly those parts of the FICC division that had large amounts of capital tied up by counterparty risk exposure in long-dated derivatives.
But UBS was a marginal player in FICC that had got out in 2008 and 2009, got back in again in 2010 and never quite enjoyed the prominence the bank has in equities. Barclays is different. It is a market leader in FICC, as its strong showing in Euromoney’s rates survey indicates. And Jenkins chose instead to re-emphasize his commitment to the business, which is a driver of earnings at Barclays’ biggest division.
The troops, never short of confidence, are enthused. For the biggest firms, rates remains a good business, with margins not yet as compressed as in foreign exchange and volumes supported by the vast increases in government debt issued in recent years. As fringe players withdraw, volumes have remained good for the survivors. The head of a rival top-five firm tells Euromoney rates volumes have increased 250% from 2009.
As the top-ranked player, Barclays is a big beneficiary. “The business has become more complex and that rewards scale because of the investment required,” says Nat Tyce, head of global rates trading at Barclays. “You need a very broad distribution franchise to recycle risk between clients of different types in different regions. That recycling rather than simply warehousing risk is what we focus on. We have invested in e-trading and clearing technology and introduced new models for pricing multi-asset CSAs and also the more credit intensive uncollateralized business. We’ve also set up a treasury area within rates which ensures rapid and consistent decision-making about commitments.”
Most of the leading firms agree that while the more commoditized FX market has thousands of clients that banks need to cover through low-touch electronic channels, the rates market is more mixed. There are just a few hundred key institutional accounts that may be happy to put many smaller tickets through electronic channels but need closer coverage for larger trades and portfolio-shifting ideas. In illiquid markets, they might increasingly see an advantage in dealing with a bank that has a sufficiently large franchise to be more likely to find a third party ready to take an offsetting position.
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| Kashif Zafar, head of global rates distribution and e-distribution |
Kashif Zafar, head of global rates distribution and e-distribution, says: “Close to half of our US rates institutional client business is conducted with clients outside of the US. As a result of the diversity of our global client base, we are more likely than our competitors to find the uncorrelated flows that allow a client franchise to become successful in getting business done with each client trading a specific product. The depth of our client franchise in Europe has allowed us to gain a significant lead in rates cash products over our closest competitors. And our business with Asian clients has more than doubled over the past five years and continues to grow as the Asian investor base looks for investment opportunities across the world.” It’s almost brazen talk, but it shows, even more than self-confidence, a driving hunger to capture more of those uncorrelated flows. Barclays’ pitch is that if a US client wants to sell treasuries, it has a materially higher chance of finding the European or Middle Eastern client that wants to buy. “We commit balance sheet to allow our clients to transfer risks but our model is not about accumulating long-term balance-sheet exposures. It’s because we’re confident we can shift risk that we bid competitively for it,” says Tyce.
Of course all inventory businesses suffer when the underlying asset class declines. But even in down markets dealers can benefit from volatility and volume. It’s the absence of volatility, in the funk periods when no one does anything, that kills trading businesses. Volatility has returned to rates this year.
And as to volumes, spendthrift governments have provided an abundance of raw material. Zafar says: “The total size of the US Treasury market was roughly $3 trillion at the start of 2003. Ten years later, it stands at over $11 trillion. According to the Congressional Budget Office, even if president Obama’s deficit reduction plan is passed by Congress, the resulting deficits will still drive the outstanding amount of US treasuries to more than $18 trillion by 2023, a 60% increase in the next 10 years.” Taxpayers may weep, but not bond traders.
The biggest risk Zafar sees for the business is in getting left behind in the technology race. Barclays analyses how much of its business flow is Barx-able: that is how much can it do electronically. It reckons that 90% by number of the trades it does in government cash bond markets are now struck electronically, which is a low-cost, efficient way of dealing. That high number of trade tickets constitutes about 50% of volumes. The big development now is new regulation driving a big transformation in rates derivatives markets where today only 5% to 10% of client business by volume is done electronically. In the next few years, the firm sees that proportion growing quickly to above 50%. “We’ve been preparing for this transformation since we launched interest rate swaps on our Barx platform in 2003 and through innovative product development since then. Leading the change on the technology front is critical to our medium- and long-term success with our clients,” says Zafar.
