Banks take big risks in government bonds |
THEIR PEERS MARK out Barclays, Deutsche Bank and JPMorgan as the big three in the rates world. These are the firms with the best-established trading presences and strongest distribution networks in the developed-world government bond markets and associated interest rate derivatives. Euromoney’s survey, asking 1,200 of the biggest investors in government bonds and users of interest rate derivatives which firms they put their business through during the 12 months from September 2009 to September 2010, largely bears this out. Barclays Capital’s market share, looking in aggregate at government bonds and interest rate swaps across the maturity spectrum from two years to 30 years, is impressive enough in dollar rates and stunning in euros. Harry Harrison, head of rates trading at Barclays Capital, says simply: “We have a wide variety of investing clients with quite divergent needs and views. Today, while bank dealers are offering reasonable balance sheet and liquidity, the supply of government bonds is huge and the intra-day volatility can be high. The fear of a cliff event means dealers don’t want to hold the same amount of risk they used to for an extended period, and so the ability to redistribute bonds through that large investor base is very valuable.” As well as a diverse client franchise, Harrison points out: “Our position is also based on continuous investment over many years in people, IT and market infrastructure. Plenty of banks may have been attracted to this business lately, but the investment required to be a scale player is significant. Success doesn’t happen overnight.”
In part BarCap’s extraordinarily high market shares might also reflect the fact that Euromoney’s survey covered the period when fears about the capacity of several developed-world sovereign borrowers to service their debt burdens first broke out. In a crisis, the market share of the top dealers can quickly climb by several percentage points as customers flock to the best-established and most reliable firms. In better times, when more banks come back to compete, those shares can fall.
Competition was also heating up strongly in the rates business during Euromoney’s survey period.
HSBC’s strong showing in both the euro and dollar rates markets suggests that the big three might now be a big four. Competitors acknowledge that HSBC has upped its game recently in both the primary and secondary markets when governments are desperate to get successful offerings away.
“From a margin point of view, rates is still a good business to be in; that’s why many banks have refocused on it, post the financial crisis,” says Elie El Hayek, global head of rates at HSBC. “Whether because we were lucky or well managed, HSBC was one of the winners from that crisis. Our big advantage is that we are close to many of the governments. Also, markets have become somewhat more domestic in this phase of concern over sovereign debt and, as well as being primary dealers, we are often physically present in the domestic markets as a local retail and commercial bank.”
And until interest rate derivatives move across entirely to central clearing counterparties, HSBC’s credit rating and the perception that it is one of the most conservatively funded banks is also a benefit. The less-well-rated firms like to point out that collateralization has made dealer counterparty credit risk less of an issue in rates derivatives. But even if a client has collateral to protect it against a counterparty collapsing when the client is in the money, it is still left vulnerable to market movements as it seeks to replace its positions and hedges.
Fighting back
Some of the banks that were so damaged in the financial system collapse as to require state-sponsored rescues in 2008 and 2009 have been back and fighting hard to re-establish themselves in rates for some time already. Beneath the leading three or four firms in each main currency market, with their double-digit and high single-digit market shares, a cluster of big banks are fighting it out. “It takes time to get a big salesforce and a big organization working well together but Citi has improved a lot. I think we’re going from top 10 to top five,” says Andrew Morton, global head of G10 rates, risk treasury and finance at Citigroup.
Many of the leading asset managers, and even the relatively understaffed reserve managers and bank treasurers that do a lot of rates volume with their top-three intermediaries, will have a core group of at least half a dozen banks that they also do regular business with.
“The high levels of volatility in the government bond market mean there’s a lot to play for if you’re a manager seeking to extract alpha based on issuer selection,” says Chris Murphy, global head of rates derivatives at UBS. The bank clearly sees plenty to play for. “Compared with 18 months to two years ago when we fell away from the landscape, we feel that UBS is back as a major player in rates; we’ve seen our market share climb in the last 12 months.”
Murphy adds: “The move to central clearing counterparty might be quite disruptive for some of the present leaders in the rates business, and margins will come under pressure. If we can redefine our business to a lower cost base, we think we can compete very well in that lower-margin environment.”
Looking ahead
Credit Suisse is also trying to look ahead and position itself for the rates business as it will function in the next two to three years. “If set up correctly, rates and FX will continue to be attractive businesses under Basle III”, says Carlos Rodriguez, global head of rates structuring at Credit Suisse. “For years we have focused on building a capital-efficient platform, so we are further along than others in adapting to the new reality of capital and regulatory constraints. We expect to continue to invest heavily in our electronic trading capabilities and capitalize on our recent expansion in salesforce.”
And while some banks are fighting to re-establish themselves in rates after withdrawing from risk-taking in 2008 and 2009 to staunch their own losses, there are other newcomers making a push into the government bond and interest rate derivative big league.
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“I’d like to think we might establish ourselves as the first true bulge-bracket fixed-income house from Asia, one that can truly compete on the global stage” Steve Ashley, Nomura |
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Nomura, which has a very large market share in yen rates, just ahead of Mizuho Financial in Euromoney’s survey, hired Steve Ashley from RBS in May 2010 to build a global flow rates business. In the intervening nine months, he has hired some 40 professionals to staff it, roughly half from his old firm and the rest from across the market. He says that although the Japanese firm still has gaps to fill, it has already completed two-thirds of an initially projected 18-to-24-month build-out of the business. The angle is the obvious one: to build a rates business that will help establish Nomura as the pre-eminent Asian-headquartered global investment bank. Of course, this has been dreamed of many times before, while high-profile western traders, such as Max Chapman, have come and gone at Nomura. “We have to demonstrate consistency and credibility over longer than just two years,” acknowledges Ashley, “but we feel that the playing field is more open now than it was before.” The travails of European sovereigns and even the US government give a new edge to Nomura’s latest effort.
European sale
“There is something like a trillion dollars of net new inflow coming into the hands of Japanese households over the next few years and that potential source of new investment funds is attractive to many European borrowers,” Ashley says. “Japanese investors have been familiar with dollar assets, but the political construct developed in Europe over the past 10 to 20 years seems mysterious to them. So demystifying Europe and bringing European product to Japanese investors, at a time when there are some enticing sovereign spreads beyond Germany and France, will be a big theme for us.”
Ashley adds: “We did a European agency deal recently where we substantially outsold our western bank co-lead partners on the back of very large individual orders that were unique to ourselves. We like to think that we can bring different and previously untapped capital flows.”
Nomura’s rivals, needless to say, suggest it is buying market share, a charge that Ashley rebuts. They are all keeping a close eye on Nomura. Can it succeed? Ashley takes an example from the present eurozone champion among the big-three market leaders in rates.
“Fifteen years ago, Deutsche Bank had a similar vision to ourselves, hired in a lot of people from Merrill Lynch and other firms and built onto a commercial and retail bank the flow platform of a global investment banking powerhouse,” Ashley says. “Our proposition is different, but I’d like to think we might have a chance of making a similar kind of impact and establish ourselves as the first true bulge-bracket fixed-income house from Asia, one that can truly compete on the global stage.”
