VOL. XXII, NO. 16 / April 22, 2013
Exclusive Insight for Derivatives Buyers, Sellers and Structurers
Derivatives Week
The weekly issue from Derivatives Intelligence
www.derivativesintelligence.com
Credit | 3
FX | 4
Rates | 6
Equity | 8
CS In Best-Of Bonus Structure
Credit Suisse has launched best-of bonus structured certificates
on a basket of three underlying stocks, a novel offering according
to investors.
The best-of bonus certificates offer investors unlimited
participation in the positive performance of the best performing
underlying stock referenced by the certificates, or at least a
minimum payment of the 100% bonus level, should a barrier event
not occur before maturity. The underlying stocks are Nestlé,
Zurich Insurance Group and ABB.
Regulation | 11
Final Redemption Scenarios
Bonus Level
A Bonus Level
A
Barrier
Barrier
B
B
Bonus Level
Bonus Level
Barrier
Barrier
• If none of the shares has ever traded at or below its barrier, the
investor will receive the denomination plus 100% of the positive
performance of the best-performing share on the final fixing date,
calculated from its initial level.
• The investor will receive a minimum repayment of the bonus level.
• If at least one share has ever traded at or below its barrier, the
investor will receive the predetermined number of shares of the
worst-performing reference share.
• Fractions will not be cumulated and will be paid in cash.
Source: Credit Suisse
(continued on page 24)
Industry Bigwigs Set Out
Electronic Trading Challenges
Derivatives Week has brought together a group of senior
officials to discuss current developments in the electronic
trading of derivatives. Among the topics debated were
proposals in the U.S. around a minimum of five RFQs, the
outlook for the single-name credit market once clearing goes
live, and the challenges to developing and rolling out electronic
platforms in the current environment.
The roundtable participants were Ryan Sheftel, global head of
fixed income, fx and commodities e-commerce at Credit Suisse,
Sonali Das Theisen, director in credit trading at Barclays,
Athanassios Diplas, senior advisor to the International
Swaps and Derivatives Association’s Board of Directors, Sam
Priyadarshi, head of fixed income derivatives at the Vanguard
Group, and Jim Rucker, credit and risk officer at MarketAxess.
(See page 13 for the full roundtable)
Q&A
UBS’ Naylor: Buyside Convexity
Demand Spikes
Institutional investors are showing increased demand for
convexity on the S&P 500 in instruments such as wing options
or by buying a variance swap and selling a volatility swap on the
index, Roger Naylor, head of global equity derivatives at UBS
in London, told DI in an exclusive interview. Volume has yet to
increase sharply, but requests are up given cheap convexity.
“I think, logically, given the uncertainties in the world and the
fact that convexity has recently become a lot cheaper to own, it
makes sense to look at it,” Naylor said. “Relatively few people
are pulling the trigger on the trade because there’s still a lot of
faith in policy makers’ ability to stop us falling back into a full-on
crisis. They’re also expensive positions to carry, even at the
current levels.”
(continued on page 22)
People Databank
RBS Floats Custom Fund Play
Regulatory Alert
Track all the relevant staffing comings and
goings in derivatives. Inside, we’ve got a
month-to-date running tally of which firms
have been hiring and which firms have
been losing staff.
The Royal Bank of Scotland in Japan
is marketing UCITS-compliant funds
embedded with the firm’s custom
proprietary indices.
Check out our interactive database of
new and pending regulatory proposals
and directives that relate to derivatives
collected from global regulatory agencies.
See page 19
See story, page 8.
Visit the data section of
www.derivativesintelligence.com
Unauthorized reproduction, uploading or electronic distribution of this issue, or any part of its content is illegal without the Publisher’s written permission. Contact us at (800) 437-9997.
DerivativesWeek The weekly issue from Derivatives Intelligence IN THIS ISSUE
www.derivativesintelligence.com
Derivatives Intelligence
CREDIT
EQUITY
3 |Javelin Opens London Office, Eyes
Product Expansion
9 |VIX Calendar Calls Find Favor
EDITORIAL
9 |Citi Equities Bigwig Departs
Steve Murray
Emmanuelle Rathouis
Editor
Marketing Director
Tom Lamont
Vincent Yesenosky
General Editor
Head Of U.S. Fulfillment
(212) 224-3057
3 |Ex-UBS Credit Bigwig Joins Fund
Manager
FX
4 |UBS Markets Digital Basket Note
5 |Citi Upgrades Corp Fx Platform
REGULATION & CLEARING
11 |Brokers See SEF Record-Sharing
As Tough To Meet
11 |ISDA: Margin Proposals Could
Leave Risks Unhedged
INTEREST RATES
DEPARTMENTS
6 |STOXX Launches Libor, Euribor
Alternative
13 |Electronic Trading Roundtable
6 |CS Hires Ex-UBS Rates Trader
6 |RBS Pitches SEK Forward
Steepeners
7 |IOSCO Issues Benchmark
Consultation
19 |People Databank
20|Learning Curve
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This week’s stories and analysis can be found on the following pages:
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4 |
AUD, RMB Deal To Drive Deriv Development
CORPORATE
Jenny Lo
An agreement that will allow the Australian dollar to be settled directly with the yuan in
the spot market will grow volumes of fx deliverable forwards and options once further
deregulation occurs in China, according to market participants.
Richard Ensor
Chairman
Web Production &
Design Director
John Orchard
Managing Director,
Capital Markets Group
8 |
Korean Tensions Open Up Kospi Put Spread Possibilities
Hedge funds have been buying short-dated at-the-money put spreads on the Kospi at 2%
with a 90% strike, in a bid to profit on a recent change in skew due to escalating political
tensions on the Korean peninsula.
8 |
RBS Tokyo Floats Custom Fund Play
The Royal Bank of Scotland in Japan is marketing UCITS-compliant funds embedded
with the firm’s custom proprietary indices.
9 |
Investors Roll Nikkei Calls
Large global institutional investors are increasingly rolling their call positions up-and-out
on the Nikkei in a bid to switch short-term exposure to long-term exposure on the index as
the Japanese equity market continues to spike.
9 |
JPM Loses Tokyo Trading And Execution Chief
Shaun Moran, managing director and head of trading and execution services at
JPMorgan in Tokyo, left the firm this week.
12|
Foreign Synth. ETF Providers Face South Korea Restrictions
Foreign synthetic exchange-traded fund providers will not be allowed to directly list or
market their ETFs in South Korea’s soon to-be-launched synthetic market.
Customer Service
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12|
Fragmented Asian CCPs Could Hurt Liquidity, Spreads
Fragmented central clearing in Asia could hit bid/ask spreads and liquidity of cleared
over-the-counter derivatives if dealers and end-users are forced to join a number of
separate national clearinghouses.
2 © Institutional Investor, LLC 2013
VOL. XXII, NO. 16 / April 22, 2013
Derivatives Week The weekly issue from Derivatives Intelligence www.derivativesintelligence.com
Credit
Ex-UBS Credit Bigwig
Joins Fund Manager
David Gallers, the former head of credit default swaps index
trading at UBS in New York, has joined corporate credit investment
manager Lucidus Capital Partners as a portfolio manager.
Gallers joins the firm from UBS in a new role. He left UBS in
November last year, where he was replaced by algorithms that
trade using mathematical models, according to news reports.
Gallers could not be reached. Simon Meadows, a partner at
Lucidus in London, confirmed the hire.
Javelin Opens London Office,
Eyes Product Expansion
New York-based Javelin Capital Markets, which runs an interest
rate swaps and credit derivatives trading venue, has opened an office
in London following a spike in demand from end
users in Europe.
The office, targeting Europe, Middle East
and Africa customers, is headed by Dan Moon,
who previously worked at HSBC, Bank of
America and Santander.
James Cawley, ceo in New York, told DI
James Cawley
the firm plans to register as a swap execution
facility under
Clearing Firm
the DoddBuyer
Buyer
Frank Act once
SEF rules are
Buy_Accept
E-APPROVAL
finalized. “And
PR
then from there
BUY TICKET
we expect to
broaden our
SELL TICKET
product mix
PRE-APPROVAL
Sell_Accept
from interest
rate swaps
Clearing Firm
and spreads,
Seller
Buyer
to include
Source: Javelin
butterflies,
curves and so
on in dollars. A lot of liquidity providers are European banks so
the next step then is to quote euros and sterling.”
The firm will launch its anonymous all-to-all swaps trading venue
in London in the coming weeks. “Based on solid demand from
European customers, it made sense to accelerate our European
deployment,” said Moon, in a statement. “A number of institutions in
Europe have realized that the swaps markets are evolving and will
offer customers more choice.”
Javelin was formed in 2009 as a derivatives execution platform
for IRS and credit default swaps, offering both anonymous
electronic and voice-hybrid methodologies for trade execution.
Barriers Broken In Euro Debt Auctions
By Gavan Nolan, credit analyst, Markit
Another week in the sovereign markets and yet more barriers are
being broken down.
France, Spain and Slovenia all have their problems but they
also managed to sell debt this week. The 0.73% yield on France’s
five-year OAT bond auction was the lowest on record, following
on from the record 10-year yield achieved earlier in April. Spain’s
auction the same day was also notable. The sovereign sold EUR4.7
billion of debt, above its maximum target of EUR4.5 billion, and the
yield on the 10-year issue was the lowest since September 2010.
Spain has now covered 39% of its planned medium- and long-term
funding needs for the year.
It was perhaps no surprise that major European sovereigns such
as France and Spain should sell debt without a hitch. But Slovenia
is a different proposition. The Balkan country has been affected
by the fallout from Cyprus’s bailout–some investors see it as the
next most vulnerable sovereign in the Eurozone—its credit default
swap spreads widened sharply as a result. At the start of the year
Slovenia’s five-year CDS was trading at 232 basis points; by late
March it was quoted at 400bps.
The spreads have since recovered slightly, and a successful
VOL. XXII, NO. 16 / April 22, 2013
auction of 18-month treasury bills this week
helped the sovereign’s cause. The government
sold EUR1.1 billion of debt, more than double its
target, and gave the country some much-needed
breathing space.
However, it is likely that a considerable portion of the bill buying
came from state-owned banks, where Slovenia’s main problems
lie. The banking sector has considerable amounts of bad loans,
and the bulk of these are on the balance sheets of state-owned
institutions. On the positive side, Slovenia’s banking industry is
relatively small in terms of its GDP, and bears no comparison with
Cyprus. If it can implement swift privatisations of its banks then it
may be able to avoid a bailout.
All European countries, and in particular France and the
peripherals, are benefitting from the glut of liquidity emanating from
the Bank of Japan. The search for yield makes it relatively easy
to sell debt. But that is obscuring the economic fundamentals in
Europe, which remain dire. Investors are prepared to ignore this
while central banks are intervening, and it will take a major negative
catalyst to shift sentiment.
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3
Derivatives Week The weekly issue from Derivatives Intelligence www.derivativesintelligence.com
FX
F
low in the fx market was broadly muted last week although the yen continues to remain
a hot topic among strategists. Société Générale was suggesting opportunities to take
advantage of the continued weakness in the yen by buying six-month seagulls on the U.S.
dollar/JPY. Other Asian currencies were also in the limelight, with market participants expecting a
spike in deliverable forwards and options on the back of an agreement that will allow the Australian
dollar to be directly settled with the yuan.
AUD, RMB Deal To Drive Deriv Development
An agreement that will allow the Australian dollar to be settled
directly with the yuan in the spot market will grow volumes of fx
deliverable forwards and options once further deregulation occurs
in China, according to market participants.
China and Australia last week sealed an agreement which made
AUD the third currency after U.S. dollar and the Japanese yen to be
able to settle directly. According to William Johnson, senior fx dealer
at Sydney broker World First Foreign Exchange, further development
between China and the Australian forward and options market is
needed before real increases in volumes is seen. More deregulation
from the Chinese Government and a willingness from counterparties to
create liquid markets for such products will need to follow, he said.
Johnson said the initial benefits of the agreement will be seen
in the spot market. “This is a further movement towards freeing
RMB and I feel derivative volumes will increase as this process
continues,” he added. “However I envisage this single action on its
own will have little effect on derivative volumes from the outset. It is
aimed initially at delivering RMB through spot trades for settlement
of trade in goods and services.”
HSBC said in a statement the deal was a vital move towards
building a representative and liquid onshore benchmark for major
non-USD crosses. The firm also received approval from the People’s
Bank of China last week to be one of the first market-makers for direct
trading of RMB and AUD in China’s interbank foreign exchange market.
Yen Weakness Sparks Seagull Opps
be financed quite safely in selling a put, the package forming a
seagull.” SocGen added that the 95 put strike acts as an important
psychological and technical threshold.
Many strategists have been tipping further yen weakness, driven
by the BoJ asset purchases. In a report, Credit Suisse noted that
the BoJ is displacing investors from domestic securities and forcing
an asset allocation shift in favor of foreign assets.
USD/JPY touched a four-year high Wednesday, hitting
JPY99.86. USD/JPY spot had consolidated to 98.91 by press time.
Société Générale is pitching a six-month seagull to take advantage
of the continued depreciation of the yen, as numerous banks revise
their forecasts higher on the U.S. dollar against the Japanese unit.
A seagull involves the purchase of a call spread and the
subsequent sale of a put option or vice versa; in equal amounts.
The firm specifically recommends buying seagulls with strikes at
JPY100 and 107 on the call spreads versus selling the same expiry
and notional in 95 puts. The structure indicatively costs 0.30%
when referencing spot at 99.30.
“I think it makes sense to sell both topside and downside to
finance the call strike 100. After all, you can see a seagull as a call
spread financed by a put, or just equivalently as a call financed by a
strangle,” Olivier Korber, fx volatility strategist at SocGen in Paris,
told DI. “Selling topside makes sense because [risk-reversals] are
again bids for calls, so that high strikes are expensive again.”
In a client note, the firm wrote that policy action from the Bank
of Japan has fuelled appetite for yen options, especially in topside
strikes. “This pushed up the USD/JPY implied volatility curve to
levels rarely seen in post-Lehman markets. However, USD/JPY
options are hardly expensive in vol terms.” One-month realized
volatility on the pair was 15.49% during New York afternoon trading,
well above one-month implied vol which was trading at 13.20%.
“The new bold policy mix in Japan constitutes a break from the
past and there will be no step back. So that the market is unlikely
to forcefully bid the yen in a risk-off environment. With the new
BoJ fairly limiting USD/JPY downside, a long call spread can
4 UBS Markets Digital Basket Note
UBS is launching a digital plus capital protected note that enables
investors to benefit from the appreciation of a currency basket
against the U.S. dollar.
The notes offer 100% participation, subject to a basket return
of equal or higher than 15%, and is 95% capital protected. The
equally weighted basket consists of the Brazilian real, Norwegian
krone, Canadian dollar and Russian ruble.
At expiry, if the basket return is equal or higher than 15%, then the
investor receives their denomination multiplied by the sum of 100%
plus the basket return. If the basket return is higher than 0% and lower
than 15%, then the investor receives their denomination multiplied by
100% and a coupon. If the basket return is zero or negative the investor
will only get their denomination multiplied by the capital protection.
The basket return is a total of all four currency returns divided by
four. The maximum profit potential for the note is unlimited.
The certificates have a minimum investment of USD1,000.
© Institutional Investor, LLC 2013
VOL. XXII, NO. 16 / April 22, 2013
DerivativesWeek
Derivatives
Week The weekly
weekly issue
issue from
from Derivatives
Derivatives Intelligence
Intelligence The
www.derivativesintelligence.com
www.derivativesintelligence.com
FX
Citi Upgrades Corp Fx Platform
Citigroup has re-launched its corporate fx electronic execution
platform, CitiFX Pulse 2.0
“We’ve enhanced our offerings of options. We had just plain
vanilla options on the initial release and we now have a slightly
larger suite of structured products on this release,” Umesh
Jagtiani, head of fx electronic commerce in London, told DI. “In
addition, we have revamped our exposure management module
with an enhanced framework to view, control and manage balance
sheet and cash flow exposures.”
The platform now offers structured products, such as target
and participating forwards, and the firm plans to add more exotic
structures such as knock-in forwards and multi-leg options in the
third quarter of this year.
“Pulse 2.0 caters primarily to corporates. So the basic platform
difference between Pulse and Velocity is that Pulse is a web-based
portal, whereas Velocity is an installed application which we give
primarily to our banks, hedge funds and institutional clients,” said
Jagtiani. In February, DI reported that Citi was planning to add
multi-leg options and other option payoffs to its institutional fx
electronic trading platform Velocity (DI, 02/25).
Pulse 2.0 provides access to 700 currency pairs both onshore
and through regional hubs in nearly 80 countries.
CitiFX Pulse Platform
Ready to Trade:
Coming in Q3:
s S ingle vanillas
s Vanilla structures in strip view (flexible multi-leg pricer)
s P ar-forwards
s A merican knock-in forward
s P articipating forward
s American knock-out forward
s Target forward
s E uropean Knock-in forward
s R isk Reversal
s European Knock-out forward
s S eagull
s A merican Knock-out forward with European knock-in
s P ut spread
s European Knock-out forward with rebate
s Call spread
s A merican Knock-out forward with rebate
News Roundup
Equity
Fx
• One-third of U.K. pension funds are using derivatives as an
alternative to equities, according to Aon Hewitt’s latest Global
Pension Risk Survey. (Financial Times, 4/15)
• Velocity Trade has named Sal Provenzano has head of
• Rabobank is planning to eliminate roughly half of its 50-member
fx futures, including Indian rupee/U.S. dollar contracts, in the third
quarter, subject to regulatory approval. (Hindu Business Line, 4/15)
equity derivatives staff in Asia and Europe, including Howard
Tong, head of equity derivatives for Asia. (Bloomberg, 4/15)
• Emmanuel Slezack has left Nomura Holdings as head of
index flow derivatives trading for Asia ex Japan, along with
Jean El Khoury, who was head of equities trading for the region.
(Bloomberg, 4/15)
Credit
• Credit default swap spreads for Western European sovereign
debt remained relatively stable in the first quarter despite the
crisis in Cyprus, according to S&P Capital IQ. (FTSE Global
Markets, 4/16)
• Tradeweb’s new electronic platform has drawn more than
USD600 billion in index credit default swap volumes from
interdealer-brokers, about 80% of that part of their business, since
the platform launched last October. (Risk.net, 4/15)
• Dealers appear to be warming to new credit default swap
futures. The products debut in May with four contracts from
IntercontinentalExchange, (International Financing Review, 4/12)
• JPMorgan Chase has begun using a new value-at-risk formula
for credit derivatives, the fourth such model introduced since the
beginning of last year. (Bloomberg, 4/12)
VOL. XXII, NO. 16 / April 22, 2013
institutional fx. (Securities Lending Times, 4/16)
• The Singapore Exchange has announced that it will add Asia
Regulation & Clearing
• Bloomberg has filed a lawsuit against the U.S. Commodity
Futures Trading Commission to overturn regulations that set
different margin rules for swap futures and over-the-counter futures.
(Financial Times, 4/16)
• The impact of reform of the over-the-counter markets on
fixed‑income revenue may have been overestimated, according
to a report by Morgan Stanley and Oliver Wyman. (Financial
News, 4/17)
• U.S. banks initially expressed reservations about a request made
by the U.S. Securities and Exchange Commission that they
improve disclosure of the fair value of their structured products,
according to correspondence between the institutions and the SEC.
(Risk.net, 4/17)
• The Committee on Payment and Settlement Systems and
the International Organization of Securities Commissions has
begun the process of monitoring implementation of the Principles
for Financial Market Infrastructures, which include clearing and
settlement systems, central counterparties and trade repositories.
(IOSCO, 4/17)
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5
Derivatives Week The weekly issue from Derivatives Intelligence www.derivativesintelligence.com
Interest Rates
T
he International Organization of Securities Commissions issued its long-awaited
consultation paper on its proposed ‘Principles for Financial Benchmarks,’ while index
provider STOXX launched two benchmarks to rival Libor and Euribor. The Royal Bank of
Scotland’s interest rate strategy team had its eyes on Scandinavia last week, suggesting investors
consider forward steepeners in the Swedish krona.
STOXX Launches Libor,
Euribor Alternative
Index provider STOXX has launched two
benchmarks to rival Libor and Euribor. The
STOXX GC Pooling index family provides a
representation of the secured euro funding
transactions taking place on the Eurex Repo
GC Pooling Market, effectively creating a
third-party alternative to unsecured interbank
Konrad Sippel
benchmarks.
Konrad Sippel, head of business development at STOXX in
Frankfurt, told DI, “We have seen a rising demand for transparent,
rules-based, independent alternatives to unsecured interbank
benchmarks such as Libor and Euribor/Eonia. By teaming up with
Eurex Repo, STOXX was able to develop the STOXX GC Pooling
Indices, which are based on the daily transactions on the regulated
GC Pooling market.”
Sippel said the indices can be used for benchmarking purposes
in the money markets, as well as underlyings for financial
instruments, including swaps, futures, overnight interest swaps or
structured products.
The electronic GC Pooling market run by Eurex Repo has an
average outstanding volume of more than EUR150 billion. “The
indices fulfill major requirements expressed by the working group
of 13 central banks established in March 2013 by the Economic
Consultative Committee, such as real transactions as well as clear
and binding rules,” Marcel Naas, managing director of Eurex Repo,
said in a statement.
The indices will be based on the ECB basket and the ECB
EXTended basket, two standardized fixed-income securities
baskets available on the GC Pooling Market. Each will have a
volume-weighted average rate, and total volume. STOXX has plans
to release indices that reflect the entire yield curve shortly.
CS Hires Ex-UBS Rates Trader
Credit Suisse has hired Victor Lin as a U.S. dollar interest rates
options trader in New York.
Lin joined the firm at the end of last month, according to a
U.S. Financial Industry Regulatory Authority BrokerCheck
report. DI reported that Lin left UBS in Hong Kong after the firm
announced plans to wind down its fixed-income division. At UBS he
was an executive director in yen rates options trading (DI, 11/19).
Prior to UBS, Lin was at Nomura and Deutsche Bank.
Lin’s reporting line could not be determined by press time and
spokespeople for Credit Suisse did not respond to requests for
comment by press time. Lin could not be reached.
RBS Pitches SEK Forward Steepeners
To position for no hikes in Swedish rates, the Royal Bank of Scotland
is recommending a 2y forward 2s10s steepener in the Swedish krona.
The firm noted that the strategy provides a positive roll-down
and the forward curve is 12 basis points flatter than the spot curve.
“I think that when the Swedish economy has recovered enough
to motivate a tightening of monetary policy, it will not be in the
form of rate hikes, but rather by introducing macro prudential
measures that would have the same contractionary effect,” wrote
Par Magnusson, chief analyst for Scandinavian rates, in a client
note. “Should I be correct in this view, we should not expect any
rate hikes from the Riksbank in a very long time.”
Magnusson expects the Riksbank to lower the repo rate next
time it changes its policy as inflation is far below the target of 2%,
the gross-domestic product output gap is substantial, industrial
production is trending lower, unemployment remains on the rise
and the Swedish krona is at a strong historical level.
“However, contrary to Riksbank expectations the latest
6 reading actually
saw a retrenchment
in household
leverage, which
is exactly what
the objective the
Riksbank wishes
to achieve. Add
to this the moral
and fx effect from
a June cut by the
[European Central Bank] and the potential havoc of the event
risks we are currently facing (Cyprus bail-in repercussions,
Italian politics, Slovenia, North Korea, etc.), and the risk-reward
is decidedly for lower rather than higher policy rate in Sweden.”
The firm added that the strategy would benefit from a downside
surprise to rates, while at the same time being carry positive.
© Institutional Investor, LLC 2013
VOL. XXII, NO. 16 / April 22, 2013
DerivativesWeek
Derivatives
Week The weekly issue from Derivatives Intelligence www.derivativesintelligence.com
Interest Rates
IOSCO Issues Benchmark Consultation
The International Organization of Securities Commissions has
issued a consultation paper on its proposed Principles for Financial
Benchmarks noting that compilation, distribution and governance
for financial benchmarks should be undertaken by an administrator.
In its paper, IOSCO’s Task Force on Financial Market
Benchmarks wrote that regardless of the particular structure for
benchmark compilation and administration, there must be an overall
entity which is responsible for the integrity of the benchmark. The
responsibilities would include the development, determination,
dissemination, operation and governance of a benchmark.
The 18 principles issued by the commission
include managing conflicts of interest for
administrators, benchmark design and interest,
benchmark methodology and termination of
a benchmark. In a statement, Gary Gensler,
chairman of the U.S. Commodity Futures
Trading Commission noted that, “To promote
Gary Gensler
market integrity, it is critical that benchmark
interest rates be anchored in observable transactions and supported
by appropriate governance structures.”
IOSCO added that “the data used to construct a benchmark
should be based on prices, rates, indices or values that have
been formed by the competitive forces of supply and demand
and be anchored by observable transactions entered into at
arm’s length between buyers and sellers in the market for the
interest the benchmark measures.” The task force added that
administrators need to have clearly written procedures in the
event a benchmark ceases to exist.
“Benchmarks play a vital role in the
confidence and integrity of financial markets.
The Principles proposed today are a key
step in enhancing the oversight and quality
of benchmarks,” said Martin Wheatley,
chief executive of the Financial Conduct
Authority and co-chairman of the IOSCO
Martin Wheatley Task Force. “Through IOSCO, the FCA will
continue to work closely with the European and international
community to establish clear standards for effective global
benchmarks. Once agreed, the Principles will be reflected in
future reviews of additional supervisory activity of benchmarks
undertaken by the FCA.”
Comments must now be submitted by May 16.
The Forex Forum
8 May 2013, The Brewery, London
For more information, or to apply for your place, please visit the website: www.euromoneyconferences.com/forex
Keynote Speakers Announced:
John Taylor, Chairman, CEO and Founder, FX Concepts • Neil Record, Chairman, Record Currency Management
The Euromoney Forex Forum is widely recognised as the most prestigious event in the FX calendar. Back for its 13th year with a brand
new format and plenty of new topics for discussion, it’s an event not to be missed by all those investing in or managing their exposure to
the FX markets.
Lead sponsors:
Exhibitors:
Media Partners:
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Equity
A
sia Pacific dominated index flow trading again this week, with investors globally rolling
their call positions on the Nikkei. Hedge funds are taking interest in calendar call spreads
on the VIX and Korean tensions are providing put spread opportunities on the Kospi.
Elsewhere, senior departures were also seen at Citigroup and JPMorgan.
Korean Tensions Open Up Kospi Put Spread Possibilities
Hedge funds have been buying short-dated at-the-money put spreads
on the Kospi at 2% with a 90% strike, in a bid to profit on a recent
change in skew due to
escalating political tensions
on the Korean peninsula.
The chance of the
Kospi shrinking 5%
within the next month
has increased to 15%
from 10% since the start
of April, according to a
senior equity derivative
trader in Hong Kong.
“[Skew] increased after
North Korea’s statement
of a state of war existing between the two countries,” the trader
said. “The market wasn’t really that concerned, but right from
the end of March when they made that statement we saw the
implied probabilities jumping up, and now it’s up to around 15%,
which is higher than it’s been for over a year.”
North and South Korean tensions have continued to elevate
since March, as North Korea prepared to celebrate the birth of
its founder, Kim Il Sung, on April 15. Since March, the North has
voided the 1953 armistice that ended the Korean War and detailed
plans to aim missiles at the South and its U.S. and Japanese allies.
North Korea’s rhetoric is causing retail domestic investors to
retreat from the market, with only government pension funds left as
major buyers in the nation’s equity and structured product markets,
the trader added. “If you believe the correction would be around
10%, then taking advantage of more elevated skew by buying ATM
90% put spreads for about 2% seems attractive with a risk reward
of around 5-to-1,” he said.
RBS Tokyo Floats Custom Fund Play
The Royal Bank of Scotland in Japan is marketing UCITS-compliant
funds embedded with the firm’s custom proprietary indices.
Filippo Olivetti, managing director in Tokyo, said the idea was
to embed either an offshore or domestic fund with an RBS’ dynamic
custom strategy tailored to a client’s specific view. RBS would then
distribute the fund via asset managers in Japan, who will market it
to their regional banking clients. Some corporate investors had also
signaled interest in the structures, Olivetti added.
DI reported RBS in Hong Kong was looking to structure
derivatives that reference popular UCITS-compliant funds, such as
those offered by PIMCO and Franklin Templeton, as underlyings
instead of custom indices (DI, 4/11). RBS said investors are keen
for investments with greater transparency.
Olivetti said funds have a number of beneficial aspects over simply
offering clients exposure to custom indices, including a potentially a
better accounting treatment and greater transparency. Custom indices
also benefit from high daily liquidity and low access costs, he added.
A typical structure could use Japanese government bonds as
collateral for a swap, which switches the coupon of the JGBs for the
performance of the index. The indices can also include a volatility
control mechanism to target specific volatilities and potentially
cheapen options written on the indices while providing an efficient
risk-management overlay. “There are several different types of
strategies, for example momentum based, where if a certain asset
is above the moving average it goes long, or vice versa if it’s below
8 the moving average,” Olivetti said.
He noted the underlying indices could range from referencing
a basket of equity stocks, fixed income, commodities futures
or a basket of currencies. “There are indices for example that
essentially try to play the carry trade via a dynamic strategy, where
basically you look at the rates differential that is imbedded in the
forward-implied rates and you tend to go long on the currencies
where the interest rate is higher,” he said. Olivetti added the
greatest challenge placing the structures with investors was
education. Investors need to be comfortable with the structure,
while also understanding the concept behind the index, he noted.
BNP Flow Chief Flips To Prop Desk
Jonathan Moldovan, head of index volatility flow trading for Asia at
BNP Paribas in Hong Kong, has switched to the firm’s proprietary
trading desk.
Moldovan confirmed the move, but declined to comment. He
had been in the position since June 2009, joining the prop desk
about two weeks ago. It is understood Moldovan held a similar
prop trading position prior to taking up the head index flow trading
position in Hong Kong.
Further details, such as the reason behind Moldovan’s
relocation, could not be determined by press time. A spokeswoman
at BNP did not immediately return calls.
© Institutional Investor, LLC 2013
VOL. XXII, NO. 16 / April 22, 2013
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Equity
VIX Calendar Calls Find Favor
Institutional investors and hedge funds are increasingly considering
buying calendar call spreads on the VIX as it provides the most
cost-effective way to hedge a potential spike in volatility.
The instruments are gaining interest as a cheap way to hedge
against an increase in U.S. volatility at a point when investors have,
in recent weeks, had a more positive view of the U.S. economy.
However, with the VIX nearing its six-year low and poor retail
sales data recently published in the U.S., investors are looking at
positioning for the index to gap out.
According to market participants, the majority of interest has
been in buying June13 VIX calls and selling higher strike July
VIX calls. “When we push time forward by one month in our
assumptions, there appears to be little decay, so you aren’t being
penalised too much if nothing happens. It has been so punitive from
a cost perspective to carry any kind of hedge,” said Phil Rapoport,
a strategist at Macro Risk Advisors in New York. “People are
pretty constructive on the U.S. right now so their willingness to
pay away any money to hedge has been pretty low. Therefore, the
hedging we are seeing is based on being cost effective.”
BNP Paribas is also recommending investors buy calendar call
spreads to position for higher U.S. volatility. It cites risks including
the European debt crisis and the potential escalation of the
situation in North Korea that could lead to an increase in volatility.
Investors Roll Nikkei Calls
Large global institutional investors are increasingly rolling their call
positions up-and-out on the Nikkei in a bid to switch short-term
exposure to long-term exposure on the index as the Japanese
equity market continues to spike.
Rolling call options up-and-out involves increasing the strike
and moving the maturity out on call options due to expire. It allows
investors to balance the decrease in premium for selling a higher
strike price against the greater premiums received for selling an
option that is further from expiration.
A senior equity derivative trader in Hong Kong noted the rolled
call options had strikes typically of 16,000, 18,000 or 20,000 and
maturities out to 18 months. “Newcomers are trying to catch the
train and some of the guys that have had the position for a few
months are running them on the upside,” the trader said. “Most of
the people rolling are usually unwinding a call, which is in-themoney and shorter-term into a little more out-the-money and
longer term.”
The Nikkei was trading at 13,382.89, up 161.45, during
Wednesday afternoon trading. The Bank of Japan’s continued
commitment to quantitative easing has weakened the Japanese
yen to about JPY100 against the U.S. dollar, fuelling the rally in
Japanese equity.
VOL. XXII, NO. 16 / April 22, 2013
Specifically, BNP is recommending investors to buy the Jun13
26-strike VIX call and sell Jul13 30-strike call spread. The position
benefits from the VIX futures curve flattening or inverting.
“Due to the shape of the VIX futures curve, the June 26-strike
option can be bought costless (indicative) against the July
30-strike,” wrote strategists at BNP. “The near-term contract is
closer to the money, creating more delta.”
During Tuesday morning trading in New York, the VIX stood
at 14.35.
Citi Equities Bigwig Departs
Ronan Connolly, head of equities trading for Europe, the Middle
East and Africa at Citigroup in London, has left the firm. Connolly
could not be reached. A spokeswoman declined to comment.
His departure comes after four years at the firm, where he
reported to Andy Thompson, head of equities for Europe, the Middle
East and Africa, and Simon Yates, global head of equity derivatives
in New York. He lead the expansion of the firm’s trading operations in
Europe, with hires including former HSBC single stock trader Mark
Green (DI, 3/9), former Goldman Sachs index trader Kudakwashe
Chinhara, and ex-Citadel trader Rory Hill (DI, 7/9/10).
Prior to Citi, Connolly was head of single stock derivative flow
trading in London and before that, worked as an equity derivative
trader at JPMorgan.
An equity derivative strategist based in Hong Kong said
investors in the Japanese Uridashi structured product market are
also rolling their deals, which is driving the trend in the Nikkei
call options market. “Expiring [Uridashi structured products] we
thought were just going to die and that was it, but it seems like
fresh structures have gone on again,” the strategist noted. “And
that’s keeping the December 2014 bucket of volatility very cheap,
compared to where the other money is.”
DI reported in February dealers were gearing for an issuance
spike in Uridashi autocallable structured products as dealers
sought to replace transactions that had been knocked-out due to
the Japanese equity rally (DI, 2/22).
JPM Loses Tokyo Trading And
Execution Chief
Shaun Moran, managing director and head of trading and
execution services at JPMorgan in Tokyo, left the firm this week.
Moran had been with the firm since 1995, covering cash and
equity derivatives. The reasons behind his departure could not be
determined by press time.
A spokeswoman at the firm in Hong Kong declined to comment.
Moran could not be contacted.
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Regulation
L
obbying against proposed swap execution rules continues in U.S., with the Wholesale
Markets Brokers’ Association Americas protesting against the need to keep and share
records with SEFs and the U.S. Commodity Futures Trading Commission. Elsewhere, traders
fear that proposed rules surrounding margin requirements for non-centrally cleared derivatives
could force them to leave risks unhedged.
Brokers See SEF Record-Sharing As Tough To Meet
Requiring swap execution facility to post position data for traders
would be a difficult requirement for SEFs to meet, according to
brokers. In a letter to the Commodity Future Trading Commission,
Stephen Merkel, chairman of the WMBAA in New York, wrote, “While
SEFs will monitor for manipulative and abusive behaviour, given the
competitive relationship among trading systems and platforms, SEFs
will be unable to obtain position data from other SEFs.”
The rules were expected to be finalized by the beginning of last
year, but have been repeatedly opposed by brokers since. They
would force traders to keep records of all transactions and make
them available, upon request, to the SEF and the commission.
Merkel believes that the CFTC should not adopt any provision
in the final SEF rules that requires a facility to use a large-trader
reporting system or obtain data from other sources than its own
trading system or platform.
The WMBA believes it would be impossible for firms to post the
correct data, because market participants often establish more
than one position on SEFs, making it hard to attribute a particular
position to an individual execution platform. The association also
states that many traders do not have the technology needed to
report their positions electronically, and that manual reporting
would be time-consuming and error-prone.
Messages left for the officials in the division of market oversight
at the CFTC were not returned by press time.
ISDA: Margin Proposals Could Leave Risks Unhedged
Margin requirements for non-centrally cleared derivatives
proposed by the Basel Committee on Banking Supervision and
the International Organization of Securities Commissions
could force traders to choose less effective means of hedging or to
leave the underlying risks unhedged entirely, rather than raising or
diverting funds to comply.
In a letter to BCBS-IOSCO, Robert
Pickel, ceo of the International Swaps and
Derivatives Association, said that in addition
to leaving risks unhedged, traders could avoid
undertaking risks in the underlying economic
activity. “On this reconstructed playing field,
it’s likely that many market participants would
Robert Pickel
simply abandon their use of non-cleared
derivatives and that, as a result, volumes and liquidity in the market
would shrink dramatically,” said Pickel. Under current proposals, traders would be forced to turn
to a handful of third-party custodians in order to comply with
requirements to segregate initial margins, leading to increased
concentration risk. ISDA fears this would reduce market liquidity,
tax the banking system and introduce dangerous pro-cyclical risks.
BCBS-IOSCO released the first draft of its proposed margin
requirements last summer in response to a mandate from G20
leaders and the Financial Stability Board. ISDA has opposed
the requirements several times. This latest letter comes since the
association was approved as an affiliate member of IOSCO earlier
this month. Ed Murray, a partner at Allen and Overy in London,
VOL. XXII, NO. 16 / April 22, 2013
told DI that the new affiliation is unlikely to stop the new margin
requirements from going through.
“I think there’s a real risk that these margin requirements will be
imposed. If you look at the second consultative document, Basel
and IOSCO were pretty adamant that they had a near final view
on these things,” Murray said. “One hopes that closely reasoned
arguments of this type will have an impact. My gut feeling is that
they will plough ahead with margin requirements.”
ISDA Concerns In Brief
sT
he outright quantum of margin required even in normal
market conditions is very significant. Increased initial margin
requirements in stressed conditions will result in greatly
increased demand for new funds at the worst possible time
for market participants.
s The initial margin requirements could force market participants
to forego the use of non-cleared over-the-counter derivatives
and either: (1) choose less effective means of hedging, or
(2) leave the underlying risks unhedged, or (3) decide not to
undertake the underlying economic activity in the first instance
due to increased risk that cannot be effectively hedged.
sT
he initial margin requirements should not be used as a
tool to meet objectives of policymakers to reduce risk by
encouraging more clearing. No incentive is sufficient to safely
clear non-clearable derivatives, and an incentive that seeks
to encourage such practices is inconsistent with efforts to
create robust and resilient clearinghouses.
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Regulation
Foreign Synth. ETF Providers Face South Korea Restrictions
Foreign synthetic exchange-traded fund providers will not be
allowed to directly list or market their ETFs in South Korea’s soonto-be-launched synthetic market.
Instead, the country’s Financial Services Commission is
investigating ways foreign firms can give domestic third party
providers exposure to their ETFs via swap agreements, which will
then be packaged into synthetic funds and listed on the Korea
Exchange, according to a senior official at an ETF provider in
Hong Kong. The FSC could also allow ETFs listed in South Korea
to physically invest in foreign synthetic ETFs listed abroad.
“What is being discussed by the regulator is to implement
a master-feeder structure whereby a Korean ETF invests in a
foreign ETF, and this is something that we may consider,” the
official said. “At the moment there are no immediate plans for
Korea as the tax disadvantage does not give the possibility to
cross list ETFs as we do in Hong Kong or Singapore.” In South
Korea, foreign firms operating in the country are subject to a
punitive tax regime.
The official said either option that the regulator is investigating
could allow foreign firms to indirectly take part in the Korean ETF
market and give investors there greater diversity to track more
difficult international markets. “The Korean providers also may not
have the know-how to replicate these markets just yet,” he added.
The KRX and the FSC recently announced plans to open the
ETF market to synthetic structures (DI, 3/1). The bourse expects to
see the first deals listed by the second half of the year.
An official at the KRX and spokespeople at the FSC did not
return calls.
Fragmented Asian CCPs Could Hurt Liquidity, Spreads
Fragmented central clearing in Asia could hit bid/ask spreads
and liquidity of cleared over-the-counter derivatives if dealers
and end-users are forced to join a number of separate national
clearinghouses.
Gavan Nolan, credit analyst at Markit in London, said in
research note Thursday cost is a major issue for Asia’s future
clearing marketplace. “Clearing is a volume business and CCPs in
the smaller markets could be forced to implement higher charges,”
Nolan said. “Margins will have to be maintained at the individual
CCPs rather than netted across. Becoming a member of a CCP
is costly in terms of capital.” He said institutions could elect to use
clearing brokers in some instances to save costs.
Nolan said clearing in Asia also faced other challenges due to
The world’s number one sales and marketing tool for investment managers
fragmentation, including the form collateral will take for the various
CCPs. “Fragmentation across seven different countries will be costly
and increase demand for collateral that meets the requirement
of central clearing,” he said. A further problem is that these
requirements vary from CCP-to-CCP. Some will only accept local
currency cash or government bonds, while others are more relaxed
and accept bonds issued by governments in the U.S. and Europe.”
In Asia Pacific, the Japan Securities Clearing Corp. said
recently it would start client clearing next march, while the Hong
Kong Exchange said it will allow client clearing six months-to-nine
months after interdealer clearing starts in April (DI, 10/18/12). The
Singapore Exchange has tipped it will allow client clearing in the
future, but has declined to specify a date (DI, 10/4/12).
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Electronic Trading Roundtable
Participants
Athanassios Diplas,
senior advisor to the
International Swaps and
Derivatives Association’s
Board of Directors
Sam Priyadarshi,
head of fixed income
derivatives,
Vanguard Group
Jim Rucker,
credit and risk officer,
MarketAxess
Ryan Sheftel,
global head of fixed
income, fx and
commodities e-commerce,
Credit Suisse
Sonali Das Theisen,
director in credit trading,
Barclays
Rob McGlinchey,
DW Managing Editor
(moderator)
DW: Let’s start by discussing proposals for a minimum of five RFQs
and look in more detail at the potential scenarios in terms of final
rules surrounding SEFs—how would they work? How would the
market structure evolve under those different scenarios? And what
would be the potential impact on liquidity?
Athanassios Diplas: We are still waiting for the final rules—we
are talking about rules from the Commodity Futures Trading
Commission and the Securities and Exchange Commission not
necessarily coming out at the same time. The big question mark over
the CFTC rules is the controversial five-dealer RFQ minimum that was
imposed on clients in the initial proposals. This has generated the
most dissent among dealers and clients. Our belief is that five is not
required—it is more than is required by Dodd-Frank. In a recent survey
we conducted with market participants from [Securities Industry and
Financial Markets Association], ISDA and the [Managed Futures
Association], the vast majority expressed strong concern against the
requirement for a five-dealer RFQ model. They feel that two dealers
would be more appropriate. The majority of participants also stated
that they would be more likely to trade products that are not subject to
the same rule, if the CFTC moved ahead with this rule. This, however, is
still being debated within the CFTC and we don’t know how it is going
to come out, but we remain optimistic that we will come to something
that will be more friendly to the whole marketplace. In terms of looking
at how this may evolve, I think that if the rule is amended, the impact of
liquidity would be minimal. If the rule went through in its current form,
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Electronic Trading Roundtable
then there would be a substantial impact on liquidity as it will create an
adverse condition for buyside participants that are initiating a query, in
addition to the dealer respondent.
Sonali Das Theisen: The landscape for the ideal SEF framework is at
minimum three dimensional. The trading protocols, “made available
to trade” test, and block
thresholds all have to work
well together. Ideally there
will be flexibility of trading
protocols instead of a rigid
prescription for how any
particular instrument should
trade. But to the extent that
there is a rigid prescription,
for example with an RFQ five
or a central limit order book
mandate, then it would be
preferable that only the most
liquid non-block instruments
Sonali Das Theisen
have to trade on the SEFs.
Therefore, the test for liquid and non-blocks have to be dynamic and
granular enough to adapt to the markets.
For example, for the on-the-run five-year IG index, RFQ five is not
going to be an issue because we’ve already moved beyond that—
we’re already streaming prices in that market. But the RFQ five may
be problematic for an off-the-run series or a non-five year tenor. In
those situations you would hope that either: the block threshold or
the “made available to trade” test were able to take that trade off
the SEF, or, alternatively, that a more flexible trading protocol was
allowed on the SEF such as RFQ one. We really hope that the final
SEF rules work logically in conjunction with the “made available to
trade” test and the block trade thresholds. This is one of our biggest
concerns. All three of those pieces have to function together.
Ryan Sheftel: If we take as a given what the different scenarios might
be, then I think one that has been pointed out is that the markets
are already moving to products that are inherently biased to being
ok to be traded electronically, such as index CDS. I don’t know what
the market estimates are, but I think 70-80% of index CDS is probably
electronically traded between dealers and clients. So I think, in most
scenarios for SEF rules, the products that are highly standardized, that
trade in a higher turnover might even end up being accelerated to
trading electronically. I think the market will determine how it wants
to trade those products, because at the end of the day the markets
will determine everything. The SEF rules just lay the groundwork. So I
think on one end of the coin you might just see an acceleration of an
existing pattern of behaviour that’s already been around. And then
on the other side, when you talk about liquidity, then you could just
14 see that, if the rules make it difficult for the buyside to affect their
trading, then they just choose an alternative way to express their view
or perform their risk transfer. So you could see the result being that
the liquidity in those products dries up, because what the liquidity
providers need now in terms of compensation to providing the
liquidity ends up exceeding what the buysiders are willing to pay. And
then moving on you could see a move to more proxy hedges, proxy
positions—people might move away from the securities/derivatives
that give them the exact exposure that they want, and instead move
towards things that are more proxy. So we’ll end up pushing more
of that basis risk onto the buyside and they’ll have to accept more
approximate hedging in their portfolio.
Sam Priyadarshi: I agree with the other panellists. In my opinion
most of the standardized OTC products will gravitate towards
central limit order books while much of the bespoke swaps or
cash-flow hedges or asset-swaps will gravitate to RFQ. We do have
an issue with the minimum of five RFQ, as that will deter liquidity
and impose transaction costs, also because of our fear of exposing
investment strategies to market participants who could use this to
the disadvantage of our clients or other dealers. So we think that
the minimum five RFQ will result in lower liquidity and increased
costs. An important issue that Sonali mentioned is made-availablefor-trading issue and I think we need to be very careful as to what is
“By definition, I think central limit order books
will have standardized products because you
have to show the depth of market on either
side, so that’s an important issue.”
—Sam Priyadarshi, Vanguard Group
made-available for trading—it shouldn’t just be left to the SEFs and
DCMs. It should be a joint effort between the SEFs, DCMs, buyside and
sellside as well as the regulators. We think there will be a tremendous
amount of market fragmentation on SEFs because there are currently
over 20 SEFs. Eventually there will be consolidation as buyside firms
look for liquidity and they will go to where there is the most liquidity.
Right now there is an RFQ model already in place for U.S. Treasuries
and FX, and buyside firms, go to those platforms and seek liquidity.
Dealers provide liquidity and are market-making in a RFQ manner on
those platforms. We already see some prototypes of SEFs with the
RFQ models and we’ve seen the central limit order book model. These
will work very well for standardized products, less so for bespoke
products. Eventually, we think that dealers will become agents rather
than principals—that is one part of the market structure evolution.
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And standardized products will trade on central limit order books
while bespoke or non-standard swaps will trade via RFQ’s. Again,
we feel that dealers will become SEF aggregators and might provide
cross-trading opportunities across different SEFs and DCMs.
Jim Rucker: In terms of SEF rules, we obviously expect changes but
we don’t think there are going to be a lot of significant changes to the
existing draft rules. But one of the areas that is still open to debate is
the extent to which voice trading will, or will not be allowed, under
the CFTC rules—clearly that’s going to have a significant impact. I
think it particularly impacts the distinction between the interdealer
and the buyside to dealer SEFs. That is an important issue that is still
out there that has not been raised so far. In terms of central limit order
books, I think I agree with what has already been said. I think it is very
likely that some of the most liquid contracts—whether that be index
or single-names—do over time migrate to central limit order books.
Diplas: As a clarification, I think
we should be making the
differentiation more between
liquid versus illiquid products,
not so much standardized
versus bespoke. Especially
in the credit markets,
all products are already
standardized—there’s no
difference between one
index and the other. The only
difference is that one might
be a lot more liquid than
the other one, but it’s an
identical widget, so this is
Athanassios Diplas
not a standardization issue
in terms of the differentiating factor, but rather the liquidity, and I think
that’s what’s going to make the difference between whether something
resides on a central limit order book versus whether something resides
on a RFQ. I think that the topic of what is made available-to-trade is
extremely important, and the sensitivities of both buyside and sellside
are going to equally determine how these things pan out.
DW: Athanassios, can we quickly go back to the industry survey on
RFQs. What proportion of the buyside saw five RFQs as problematic
for their business?
Diplas: So 84% of the respondents found the five RFQ proposal
problematic and that it would increase transaction costs. Around 70%
mentioned that they would migrate to different markets if that kind of
rule takes effect. However, we have to see how some of the other rules
pan out as well because, if the block is set very low, you don’t care
actually whether the five RFQ applies to you because if every trade
you do is a block then you don’t have to do five RFQs. Also, going back
to Ryan’s point, the market would like to determine how it wants to
trade, but the question is will it be allowed to determine how it wants
to trade.
Sheftel: Just going back to the point previously made on RFQ
and central limit order books, I think it is a combination between
standardization and liquidity and I think its two-step because in the
CDS market it’s already gone a step. The idea of having a central limit
order book where a person trades, generally leads to smaller trade
lots. If someone wants to do a USD100 million interest rate swap
trade and they do it in a 100 one lots each with their individual fixed
coupon, that’s just not a practical outcome. The CDS markets have
certainly solved that problem but with interest rate swaps you do have
the risk of the inability to do some of these trades, more because of
your back-office processes. It’s just the nature of that market doesn’t
fit into that model.
Priyadarshi: I think that the points that have been made about
liquidity are very important. So there are two issues here. One
is standardized versus non-standardized, and the other one is
liquidity. Just to point out, for example, the RFQ model for U.S.
Treasuries. Treasuries are standardized—about as standardized
as they get—but still they work on the RFQ model, especially for
electronic trading. Therefore, there is no central limit order
book for Treasuries and people trade several billions
of dollars every single day. Single trades can be over
half a billion or a billion or so. It’s very difficult to have
a central limit order book for bespoke products even
if they’re liquid. By definition, I think central limit order
books will have standardized products because you have
to show the depth of market on either side, so that’s an important
issue. Other issues with the RFQ model which will hamper the growth
of SEFs is the resting bids and offers and the fifteen second waiting for
the crossing of the trades. Those are some of the other issues that will
impact the development of SEFs for the RFQ model.
Rucker: I think the only thing that I would add, specifically in an
area like trading protocols, is that what’s most appropriate are rules
that are principles-based, not overly prescriptive. What we all want
is that market participants are able to determine what is the most
appropriate way of trading, and that the SEF platforms are allowed to
be innovative and creative in setting those trading protocols. We’ve
talked of two protocols – RFQ and central limit order books, but there
is also plenty of variation in between those. In my personal view, what
we want to avoid are rules that are overly prescriptive, that don’t allow
for the way the market trades today, but also don’t allow platforms to
evolve and develop as the market does.
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Electronic Trading Roundtable
Theisen: I certainly agree with that point. In and of itself, the
requirement to build a central limit order book is not overly
concerning so long as there’s not a mandate to have to trade a
particular instrument exclusively on it. But ultimately, SEFs are in
the best position to determine which segment of the market they’re
looking to service or cater to. So, if a given instrument is suitable to
migrate to trading on a central limit order book, and if a particular
SEF hasn’t built a central limit order book, then they’re going to be
at a competitive disadvantage to other SEFs. But, likewise, if certain
SEFs only want to service a specific niche or less liquid segment of the
market, then they should be free to do so. This would allow a natural
progression in the marketplace for less liquid instruments to first
start trading electronically, and then potentially advance to more
competitive trading protocols over time.
If you look at what’s happened with on-the-run CDS indices,
they have had a natural migration over the past several years, and
we do believe that ultimately some portion of this market will trade
on a central limit order book. We launched our own market-making
algorithm in 2011 to prepare for this likelihood. But it has taken some
time for clients to become acclimated to breaking up their trades
into smaller lots. It didn’t happen overnight. So you want to allow
stepping stones in the development of SEFs that support appropriate
market structure evolution.
not happen overnight, but index clearing could be the impetus for
clients to start trading some single-names electronically.
Diplas: I definitely agree with Sonali. I think credit in particular has
had some of the most unintended reverse consequences of DoddFrank, in that it was split as an asset class between swaps and securitybased swaps. So, currently, if you were to create what any market
participant would consider to be a very market neutral portfolio for
125 single-names versus the identical index, anyone would say that
should obviously have less margin than if you want to trade one side
or the other. But given the fact that Dodd-Frank considers the index
to be a swap, and 125 names to be a security-based swap, then you
“If the rule went through in its current form,
then there would be a substantial impact on
liquidity as it will create an adverse condition
for buyside participants that are initiating a
query, in addition to the dealer respondent.”
—Athanassios Diplas, ISDA
Diplas: If you look at other markets such as the DCM framework, the
service providers basically are given a lot more latitude in how to
determine their own protocols, block sizes, etc. The SEF framework is
a lot more restrictive in that sense. I think that by actually following a
similar approach to the DCM market would be healthier and we can
see how well that framework has worked. Clients definitely vote with
their feet and will vote on what offers them the best combination of
flexibility, safety, liquidity etc.
are forced currently to margin separately. So you margin basically for
these two trades as being completely separate and you have more
or less doubled the margin that you would have if you had done
only one side of the trade where the margin would be close to zero.
It’s inhibiting clients from actually doing what is rational from a risk
perspective. But right now it creates a disincentive. So the sooner the
SEC approves that rule change then we will see a lot more activity
from the client side.
DW: We’ve talked about index CDS in some detail, but looking more
specifically at credit, how is the single-name market going to develop
once clearing goes live for indices and clients have segregated pools
of collateral?
Priyadarshi: We at Vanguard think the credit index market (i.e. CDX) is
already in a move towards electronic screen trading. The single-name
CDS is going to be very tricky and there is the margining issue which,
as Athanassios mentioned, you want to take advantage of crossmargining of portfolio level margining.
Theisen: Single-names have been lagging the index side of the
business in terms of trading electronically for multiple reasons. I think
it’s reasonable to believe that as index clearing becomes mandatory
for clients, those clients will likewise want to clear their single-names,
as well as backload CDS positions. Posting of margin is going to be a
very different framework than what they’re used to. Separate pools
of collateral for cleared versus uncleared positions are just not capital
efficient. And so over time as demand picks up for clients to clear
single-names, we think clients will increasingly think about executing
these trades on a screen in some fashion to take advantage of the
downstream processing that is being established for indices. It may
16 Rucker: Personally, I do think that the single-name market is going
to migrate towards electronic trading, particularly in the most
liquid single-names. I think once firms can see the same benefits
and efficiency at the downstream processing that they get for index
contracts, it will be another factor to help drive more electronic
trading. To reiterate what the other panellists have said, margining is
an important issue and may inhibit trading volume until it is resolved.
Also, we’ve got to bear in mind that the SEC rulemaking timetable
is a long way behind the CFTC. I don’t think any of us are expecting
to see final rules for security-based SEFs for quite a few quarters and
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Electronic Trading Roundtable
therefore there is still a lot of uncertainty around that.
DW: With the development of the new market structure, greater
regulation and cost pressures on financial market participants,
particularly banks, what are the challenges to developing and rolling
out platforms and services, and how do you prioritise what to offer?
Sheftel: It’s going to be a challenge, especially on the sellside,
because the buyside is going to determine where the trading happens
at the end of the day. The banks are going to build first, because as a
liquidity provider it’s a more substantial build that you need to have,
especially in an automated world. But then
you don’t know which platform people
are going to end up wanting to trade
on. So there’s no doubt that we’ll
look back and realise that some of
the build was kind of pointless, but
we can’t predict that. So I think what
you’ll end up doing is just trying to
be smart and efficient about it. It’s
not the build per se in of itself, but
can you build to be adaptable in
the future. Regardless of where
the rules come out and how we
trade for the first six months, the
Ryan Sheftel
years after that will look different
in some way, shape or form. So it moves from building
something that you can predict to probably just thinking about being
a lot more adaptable, which is not traditionally what banks are very
good at. It causes a change in mind-set and I think that’s going to be
the biggest thing. Banks are reasonably good at building towards
large, known projects with multi-year horizons, but adaptable and
dynamic isn’t really where they usually perform the best, so it’s
changing their mentality. But at the same I think a lot of the banks are
using this opportunity to recognize this fact and are thinking ‘ok can
we change a lot of our processes?’ A lot of people are looking at this
and saying, ‘can we be smarter about how we do this because we
have a market that grew over a long period of time,’ and now you’re
reaching a breakpoint where you’re forced to rethink everything.
So I think the sellside will come out of this on the other side saying
it was a good thing for those who used this as an opportunity to
revaluate how they go about building their technology, what they
have, and using it as a reengineering exercise more than just a
bolt-on of a whole bunch of new stuff. My perception is that you’re
going to be putting a lot more demand on the buyside in terms their
capabilities. If everything is being traded electronically, one way or
the other you need technology to do that, you need more systems,
you need more technology. For many participants who are larger,
then they probably already have that. But for some of your mid-size
participants or smaller participants who’ve generally depended upon
the Street to effectively provide them with all the technology that
they needed, that might not really exist much longer. They are going
to need more than that. So they’re going to have to probably develop
technology in-house a bit more, something what they’ve not really
had to think about in the past.
Priyadarshi: From the buyside, certainly a lot of it is welcome change
because it allows for straight-through processing all the way from
portfolio management systems to the affirmation platform, to the
CCPs or SEFs or DCMs and then to our FCMs and executing dealers. So
there is obviously operational efficiency but all of this comes at a cost
to us and our clients so we do have to evaluate the costs and benefits.
Also, getting back to Jim’s point about the evolution of the market
structure in terms of what the sellside is going to offer, I think
that the revenue model based on principal and market-making
is dying. So dealers have to come up with new services such as
clearing and execution consulting whereby they’re offering a SEF
aggregation platform, where they are offering best execution
capabilities to their clients as well as cross-asset trading or
straight-trading across different asset classes. I think those
would be some of the new platforms that dealers would
be looking to build out, but all of this comes at a cost
and, as was mentioned previously, the benefits to the
dealers aren’t clear yet in terms of; if they do all the SEF
aggregation and provide all the other services, what are the
benefits to them in terms of revenue? That’s not very clear right now.
Theisen: To underscore what Ryan has already said, building
technology in an uncertain environment is very complicated,
particularly because there is necessary lead-time for projects and we
each have our own strategic views and priorities that we’re trying
to work on. There are a number of industry-wide initiatives we need
for market transformation that are still being vetted. For example,
with the certainty of clearing workflow, there are so many different
“It may not happen overnight, but Index
clearing could be the impetus for clients
to start trading some single-names
electronically.”
—Sonali Das Theisen, Barclays
considerations and all are technology-dependent. Broadly speaking,
the challenge is obviously not to be late to the party, but also not to
be too early to the party and go down a route that’s not going to be
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17
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Electronic Trading Roundtable
embraced by the market. I think that having a vision on a strategic
flexible architecture is more critical then ever. You can no longer
tackle each project ad hoc and only look at the benefit for that specific
project. You instead have to see how it fits into your overall strategic
vision of how the derivatives market is going to evolve, how the cash
market is going to evolve and how it’s going to help you in building
the right building blocks. For example if we build something for the
U.S., we should ask ourselves: can this likely be leveraged when the
rules are written for Europe, or do we anticipate the requirement
to change a lot? Its important to consider all the different scenarios
before you embark on a build. The scoping process is really complex.
Diplas: I think that’s why we have been really focussed in trying to
work on the standards and frameworks rather than specific ‘build this
one thing,’ etc, because we have to build this stuff globally. I’m not
sellside anymore but I think it’s important to understand what role the
sellside has played in the ecosystem and understand that the principle
of the risk-taking model right now might be challenged, but it is still
important enough in providing liquidity. So if you have a world where
you take the dealers out as principle liquidity providers, you have to
understand the consequences for that. Fine, if something is extremely
liquid in normal market conditions perhaps they may not be needed
However, in a more directional or volatile situation where dealers
traditionally effectively guarantee being there to put their capital at
risk and provide liquidity, that has been and is very important for the
markets. It would be very difficult to say therefore, that they will only
play an agency role going forward.
Sheftel: I just want to add two things: markets always need liquidity
providers, because while liquidity providers/market-makers maybe
don’t provide ultimate liquidity, they provide the immediacy of
liquidity and I think that’s really the key. If you look at the largest
big-cap equity names, from the reports I’ve seen still a vast majority
of the trading happens where one-side that would be deemed a
liquidity provider. So there are not a lot of examples out there of
markets that operate where all pure and natural crossing that takes
place. Therefore, there is always going to be a place for liquidity
providers and market-making because it provides a useful function
to the marketplace. I think the key though is that the rules create a
new business called the agency business. So it’s not really one or the
other, it’s really now having a liquidity providing function and now,
based upon the regulation of putting a SEF in the middle between the
price-taker and the price-maker, it creates a new industry of someone
helping the price-taker get to the marketplace. Where the regulation
could also create a quite complex marketplace, then there could be
high demand for the price-taker or the ultimate end user to really
need help finding where the liquidity is.
Theisen: I would add a comment with respect to credit. In thinking
18 about an agency model versus a principal model, there are a couple
of things to highlight. First, in an agency model, liquidity takers need
to be comfortable managing their own execution risk and breaking
up trades into smaller lots. Second, if you look at equities or other
markets where there is more of an agency component, they’re almost
diametrically opposed to credit in terms of the number of participants
to the number of instruments traded. In those markets, there are lot
of participants trading relatively few products, whereas credit has
relatively few participants trading large number of instruments. These
two factors make the agency model argument more difficult in the
credit space. This is less true with the on-the-run index market, which
we’ve already said has greater potential to move in some portion to
a central limit order book. So I believe there might be some agency
component in the credit market in the future, but it’s not our view
that the credit market will migrate predominantly towards an agency
model.
Rucker: Listening to the conversation, it seems that the extent of
the regulations and the layers of complexity in them are creating a
significant cost for all participants in the industry. I certainly know
that is the case for SEFs but listening to what other people have
said, I think that is the case for the sellside and buyside. In my view,
that creates significant barriers to entry, and it is unclear if that is
“In my personal view, what we want to avoid
are rules that are overly prescriptive, that
don’t allow for the way the market trades
today, but also don’t allow platforms to evolve
and develop as the market does.”
—Jim Rucker, MarketAxess
an intended or unintended consequence of the regulation. But
it certainly seems to me that for any participant in the industry,
whatever angle they come from, the rules are creating very significant
costs. In terms of MarketAxess as a SEF, our priorities are two-fold.
First, we obviously need to ensure that we are compliant with the
regulations; and it is difficult for us to do that at the moment until
the SEF rules are finalized. We’ve made some assumptions and had to
invest a fair amount of technology spend to prepare for it. Secondly,
another important driver of our technology spend is client demand.
Therefore, we are introducing new trading protocols, in line with the
style of trading that our clients want to do. Currently we have both
request-for-quote (RFQ) for CDS as well as live-streaming prices and
we have also built all the connectivity needed into both the swap data
repositories (SDRs) and the clearinghouses.
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People DataBank
M
ovement in the derivatives world was rife last week. Citigroup saw the exit of its head of
equities trading for Europe, the Middle East and Africa, while, JPMorgan lost its head of
trading and execution services in Tokyo. There was also a move from the sellside to the
buyside, with David Gallers, the former head of credit default swaps index trading at UBS, joining
investment manager Lucidus Capital Partners.
Month-to-Date Arrivals & Departures
Arrivals
Firm
Name
Role
Firm
Name
Role
BAML
Arnaud Droitcourt
Equity derivatives team
Velocity Trade
Sal Provenzano
Head, institutional fx
BAML
Julien Bahurel
Equity derivatives team
Citigroup
Joseph Chang
Barclays
Richard Connell
Director and head, structured rates trading
Promotion, Head, prime finance, AsiaPacific
BlueCrest Capital
Management
Yohann Freoa
Equity derivatives
Citigroup
Cornelius Griffin
Equity derivatives
Firm
Name
Role
Citigroup
Paul Mandell
Equity derivatives
ANZ Bank
David Carr
Global head, sales
Citigroup
Imran Lakha
Senior equity index options trader
BAML
Kevin Holmes
Head, U.S. dollar interest rate options
trading
Credit Suisse
Victor Lin
U.S. dollar interest rates options trader
Citigroup
Ronan Connolly
Head, equities trading,EMEA
Exotix
Stephen Best
Fixed-income credit markets group
Citigroup
Nicholas Brophy
Head, US dollar interest rates trading
Exotix
Michael Rimmell
Fixed-income credit markets group
Goldman Sachs
Yohann Freoa
Senior equity derivatives trader
Exotix
Hanspeter Jaberg
Managing director, fixed-income credit
markets group
Nomura
Emmanuel Slezack
Head, index flow derivatives trading, Asia
ex Japan
Horizons USA
Joe Cunningham
EVP and head, capital markets
Nomura
Jean El Khoury
Head, equities trading
Lucidus Capital Partners
David Gallers
Portfolio Manager
UBS
Julien Bahurel
Co-head, equity derivatives distribution
Departures
YTD Arrivals and Departures by
Location
YTD Arrivals and Departures by Asset Class
Commodities
20
Arrivals
Departures
Credit
Arrivals
Departures
15
Equity
Fixed Income
10
FX
Interest Rates
5
Structured Products
0
5
10
15
20
25
30
35
0
Hong London New Singapore Sydney
Kong
York
Tokyo
The information is gathered from our own reporting in addition to other market sources. To supply information, contact Managing Editor Rob McGlinchey in London at
[email protected], or Executive Editor Peter Thompson in Chicago at [email protected].
VOL. XXII, NO. 16 / April 22, 2013
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Learning Curve
The Financial Services Act & New U.K. Regulation Framework
By Simon Crown, Partner at Clifford Chance
From 1 April 2013, a new financial regulation framework took effect in the U.K. The
Financial Services Authority (FSA) is replaced by the Financial Conduct Authority (FCA)
and the Prudential Regulation Authority (PRA), the Bank of England is to have overall
responsibility for financial stability and a new Financial Policy Committee (FPC) of the
Bank of England is being created.
However, the Financial Services Act 2012 does more than just
give effect to these regulatory reforms. In this briefing we provide
an overview of the new framework and summarize some of the
other main areas of change, including the resolution powers
under the Banking Act 2009 and the law relating to market
manipulation.
1. Overview
The Financial Services Act 2012 implements significant changes to
the U.K. financial regulation framework by amending the relevant
provisions of the Financial Services and Markets Act 2000 (FSMA).
In addition, the 2012 Act will:
• restructure and broaden the law relating to market
manipulation and misleading statements and impressions;
• extend the scope of the special resolution regime under
the Banking Act 2009;
• create a new category of regulated activity in relation to
benchmarks (e.g. LIBOR) and credit ratings;
• change the regime for the approval, supervision and
discipline of sponsors under FSMA; and
• allow the regulation of consumer credit to be transferred to
the FCA.
2. Who’s Who
The Prudential Regulation Authority (PRA) is a subsidiary of the
Bank of England. It will be responsible for the prudential regulation
of deposit takers, insurers and major investment firms.
The Financial Conduct Authority (FCA) will be responsible for
conduct regulation and also for the prudential regulation of nonPRA firms (i.e. smaller investment firms, exchanges and other
financial services providers). It will replace the FSA as the authority
responsible for the official list under Part 6 of FSMA.
The Financial Policy Committee (FPC) will be primarily
responsible for assisting the Bank of England in achieving
its financial stability objective and will be given powers of
recommendation and direction (to the FCA or the PRA) to address
systemic risk.
The Bank of England will have overall responsibility for financial
20 Simon Crown
stability. The Bank will also be the appropriate regulator for
recognized clearing houses and will have the power to direct a U.K.
clearing house in certain circumstances.
See section 5 below for more detail.
3. Misleading Statements & Impressions Offences
The 2012 Act will restructure and broaden the ambit of the law
relating to market manipulation and misleading statements and
impressions.
The existing offence, for misleading statements and practices,
under section 397 of FSMA is being repealed and replaced by three
separate offences:
• misleading statements (section 89 of the 2012 Act);
• misleading impressions (section 90 of the 2012 Act); and
• misleading statements etc in relation to benchmarks
(section 91 of the 2012 Act).
Together, the new misleading statements and misleading
impressions offences largely cover the same ground as the existing
single offence under section 397 of FSMA. However, the misleading
impressions offence will be slightly broader than its predecessor in
that it includes misleading impressions made recklessly in addition
to those made intentionally.
The new offence for misleading statements etc in relation to
benchmarks is being introduced in response to the final report
of the Wheatley Review of LIBOR, which recommended that the
criminal law should be amended to cover manipulation of LIBOR.
4. Changes To The Banking Act 2009
Not all of the legislative change being made by the 2012 Act is
scheduled for implementation on 1 April 2013. The 2012 Act will
also be making changes to the Banking Act 2009, including the
extension of the special resolution regime (which is currently
available in respect of U.K. banks and building societies) to certain
U.K. investment firms, certain group companies of U.K. banks and
U.K. investment firms, and U.K. clearing houses. Implementation
dates for the majority of the changes to the Banking Act 2009 have
not yet been provided (although we understand, from the Treasury,
that summer 2013 is a possibility).
© Institutional Investor, LLC 2013
VOL. XXII, NO. 16 / April 22, 2013
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Learning Curve
5. Roles & Powers Of Regulators
Prudential Regulation Authority
The PRA will be responsible for promoting the stable and prudent
operation of the financial system through the regulation of all
deposit-taking institutions (banks, building societies and credit
unions), insurers and the major investment firms (together, PRAauthorized persons).
The PRA’s general objective is to promote the safety and
soundness of PRA-authorized persons. To advance that objective,
the PRA will seek to ensure that the business of PRA-authorized
persons is carried on in a way which avoids any adverse effect on
the stability of the U.K. financial system. It will also seek to minimize
the adverse effect that the failure of a PRA-authorized person could
be expected to have on the stability of the U.K. financial system.
Additionally, commensurate with its responsibility for regulating
insurers, the PRA has an insurance objective: to contribute to the
securing of an appropriate degree of protection for those who are or
may become policyholders.
In discharging its general functions, the PRA is to have regard
to the regulatory principles applicable to both the PRA and the FCA
and also to the need to minimize any adverse effect on competition
in the relevant markets.
The 2012 Act also makes provision for the setting of further
objectives.
Financial Conduct Authority
The FCA will be responsible for regulation of conduct in retail, as
well as wholesale, financial markets and the infrastructure that
supports those markets. The FCA will also have responsibility for
the prudential regulation of firms that do not fall under the PRA’s
scope.
The FCA’s strategic objective is to ensure that the relevant
markets function well. Its operational objectives are: to secure
an appropriate degree of protection for consumers; to protect
and enhance the integrity of the U.K. financial system; and to
promote effective competition in the interests of consumers in the
markets for regulated financial services or services provided by a
recognized investment exchange in carrying on exempt regulated
activities. The FCA is tasked with maintaining arrangements for
supervising authorized persons, monitoring compliance and taking
enforcement action.
The FCA will have a wide range of rule-making powers, which in
some cases go beyond the powers currently enjoyed by the FSA.
For example, the FCA will have the power to make product
intervention rules, prohibiting authorized persons from
entering into specified agreements if the FCA considers it to
be necessary or expedient for the purposes of advancing the
consumer protection objective or the competition objective (the
Treasury may by order extend this to include also the integrity
objective). Contravention of a product intervention rule could
VOL. XXII, NO. 16 / April 22, 2013
lead to the relevant agreement or obligation being unenforceable
against any person or specified person, and to the recovery
of money paid or property transferred and to the payment of
compensation.
Co-ordination & Co-operation
The PRA and the FCA have a duty to co-ordinate the exercise of
their functions.
In certain circumstances, the PRA may, if it considers
it necessary, direct the FCA to refrain from exercising its
regulatory or insolvency powers in relation to PRA-authorized
persons if the PRA is of the opinion that the exercise of the
power in the manner proposed may threaten the stability of the
U.K. financial system or result in the failure of a PRA-authorized
person in a way that would adversely affect the U.K. financial
system.
Both the FCA and the PRA must take appropriate steps to cooperate with the Bank of England in connection with, among other
things, the Bank’s pursuit of its financial stability objective.
Financial Policy Committee
The FPC is a sub-committee of the Court of Directors of the
Bank of England, consisting of the Governor of the Bank, the
Deputy Governor of the Bank, the Chief Executive of the FCA, a
member appointed by the Governor of the Bank after consultation
with the Chancellor of the Exchequer, four members appointed
by the Chancellor of the Exchequer and a representative of the
Treasury.
The FPC is primarily responsible for contributing to the
achievement by the Bank of its financial stability objective
(the FPC also has a role in supporting the economic policy
of the Government, including its objectives for growth and
employment). To this end, the FPC will identify, monitor and
take action to remove or reduce systemic risks with a view to
protecting and enhancing the resilience of the U.K. financial
system.
Those risks include systemic risks attributable to structural
features of financial markets, such as connections between
financial institutions, systemic risks attributable to the distribution of
risk within the financial sector, and unsustainable levels of leverage,
debt or credit growth.
The FPC may give directions to the FCA or the PRA requiring
them to exercise their functions so as to ensure the implementation
of a macro-prudential measure (prescribed by the Treasury by
order) described in the direction.
In addition, the FPC may make recommendations within
the Bank, including as to the provision by the Bank of financial
assistance to financial institutions and the exercise by the Bank of
its functions in relation to payment systems, settlement systems
and clearing houses.
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21
DerivativesWeek
Derivatives
Week The
Theweekly
weeklyissue
issuefrom
fromDerivatives
DerivativesIntelligence
Intelligence
www.derivativesintelligence.com
www.derivativesintelligence.com
Q&A
Roger Naylor, UBS
Roger Naylor is head of global equity derivatives at UBS in London. He joined in
the summer from Deutsche Bank, where he was head of global equity derivatives
and global head of equity risk. He spoke to Managing Editor Rob McGlinchey and
Associate Reporter Hazel Sheffield regarding UBS’ growth plans, his views on the
great rotation and current popular equity derivative strategies on the Nikkei.
DI: You’ve been at UBS now for around seven months. What
attracted you to the firm and how are you planning to develop
its equity derivative business globally?
Roger Naylor: A number of things attracted me to UBS, starting with
the firm’s clear commitment to global equities and equity derivatives.
Leadership in structured products and the strength of the franchise
were very important; especially the dominance in Asia Pacific which
is a region I believe is particularly difficult to break into.
In terms of areas we’d like to develop further, I see a strong
future for corporate derivatives where UBS is already a significant
player. For the last decade this has been an interesting and
profitable business and I see no reason why it won’t continue to be
a major contributor to the overall equity business. In Asia Pacific
we have a very strong franchise for both linear and non-linear
corporate derivatives. In EMEA we are a significant player and still
growing and likewise in North America.
DI: In South America, how big is the corporate derivatives
market?
RN: It’s an open question. There’s clearly a demand for financing
structures in Latin America as there is in Asia and emerging
Europe. My personal opinion is that there hasn’t been as big a
revenue opportunity in Latin America but I think that may change.
So it’s an area we’re watching, but it’s not currently as active as
Asia and emerging Europe.
DI: Looking at Asia, a lot of your competitors are looking at
developing their equity derivatives presence, particularly
corporate derivatives, in countries like Vietnam, Indonesia,
Thailand and Taiwan. Have you already got a presence in
those countries?
RN: Yes, we definitely have a presence in those countries already.
As I said, our Asia franchise is one of the things we’re most proud
of so the fact that we already have a great corporate derivatives
business and we’re strong in Asia Pacific intersects nicely. We’re
well beyond just being active in one or two of the larger markets,
and have deep relationships across the entire region.
22 Roger Naylor
DI: What are your views on two other countries that are being
focused on more by the sellside and investors in equity
derivatives—South Africa and Turkey?
RN: These are two very different markets. South Africa is
a very mature market where derivatives have been traded
actively for over a decade. Turkey is a much newer market for
derivatives and also for retail structured products. UBS has a
good presence there, with cash traders and research analysts
locally as well as some macro research coverage from London.
Our cash market share has been growing and we find the market
attractive.
In terms of the derivative opportunities I don’t think there’s an
enormous amount of flow derivative business right now in Turkey,
aside from the listed futures that trade in decent volume. The
business we’re doing tends
to come through our wealth
“For the last decade
management division. We have
this has been an
capability in both index and
interesting and
single stock derivatives and
profitable business and I do think it’s an interesting
and growing market. Given
I see no reason why
it won’t continue to be UBS’s strength in retail public
distribution products globally—I
a major contributor
think it’s fair to say we’re number
to the overall equity
one by volume if you consider
business..”
Hong Kong, Germany and
Switzerland--it’s a logical next
step for us to look at Turkey, and maybe for international as well as
local underlyings.
DI: How much of an advantage is it for UBS’ equity derivatives
and structured products business to have an electronic
platform such as Equity Investor?
RN: It’s significant. Equity Investor gives us an advantage because
transacting through it requires no manual intervention and therefore
we can handle very small ticket sizes, even down to a few thousand
dollars notional. It’s definitely an important part of our structured
© Institutional Investor, LLC 2013
VOL. XXII, NO. 16 / April 22, 2013
DerivativesWeek
Derivatives Week The
issue
from
Derivatives
Intelligence
Theweekly
weekly
issue
from
Derivatives
Intelligence
www.derivativesintelligence.com
www.derivativesintelligence.com
Q&A
products business.
One thing I would add is that the structured products business
goes beyond servicing UBS Wealth Management, although that
is clearly a critical part of it. We also provide solutions to private
banks around the world.
DI: What’s your current take on the great rotation, where
investors are moving out of fixed income products into equity
derivatives products?
RN: I think it’s a bit
premature to get very
“Significantly though, in
excited about this
Europe we recently facilitated story. I’ve seen it
several transactions whereby mentioned a lot, and
insurance companies bought there’s continual hope
within the equity world
long-dated structured
that this theme is real
calls instead of buying the
and will be sustained.
underlying equities, which is At the beginning of
more efficient for them under this year it did feel like
Solvency II.”
we were witnessing
a rotation due to the
dramatic pickup in
equity structured product volumes. I think it’s premature to say
that we’re seeing a big rotation into equities though--whilst
there has been some movement out of investment-grade credit,
much of this has actually been into high-yield credit. On a
positive note for our business, there’s been a clear increase
in demand for high-yield equity structured products, reverse
convertibles and autocallables. We’ve also had a lot more
requests for products based on high dividend-yielding stocks.
Whilst expectations of continued low interest rates are driving a
hunt for yield, I’m not sure it’s yet got to the point where we can
call it a fully fledged rotation.
DI: Volume in Vstoxx options and mini-futures has increased
significantly over the last year. In what ways are you seeing
institutional investors now use the Vstoxx not only for
hedging, but also to generate alpha?
RN: The main activity we witnessed so far was from institutions
using Vstoxx as a proxy hedge for their equity exposures. When
the VIX and the VSTOXX have been low we’ve seen interest to
buy call spreads and call flies on these indices. The other activity
we’ve seen on both indices has been hedge funds trading the
shape of the term structure. We have a couple of new products
that have launched including the UBS DOVE index which has
several different forms and is targeted at institutional investors. It
gives you either outright exposure to volatility or exposure to the
shape of the curve. In terms of the actual volume going through
the VSTOXX, it hasn’t picked up as quickly as I hoped it would.
VOL. XXII, NO. 16 / April 22, 2013
While the growth rate has been impressive it’s still got a very long
way to go before it becomes anywhere near the scale of the VIX.
DI: What’s unique about DOVE compared to other volatility
products?
RN: It’s a simple and transparent way for institutions to get
enhanced exposure to equity market vol. We believe our backtesting shows the algorithm behind the strategy to be lower risk and
higher performance than other products in the market.
DI: Have you seen an increase among institutional investors to
buy convexity on the S&P 500 recently?
RN: There’s more demand for convexity generally, through wing
options and also variance versus vol. I wouldn’t say there’s been
a huge pickup in activity yet but we’re fielding more requests for it.
I think, logically, given the uncertainties in the world and the fact
that convexity has recently become a lot cheaper to own, it makes
sense to look at it.
Relatively few people are pulling the trigger on the trade
because there’s still a lot of faith in policy makers’ ability to stop us
falling back into a full-on crisis. They’re also expensive positions to
carry, even at the current levels.
DI: This year has all been about Nikkei and Japan, when you
take into consideration volumes. What do you feel is the
next stage in terms of equity derivative strategies to play the
increase in Japan’s equity derivative market? For example,
do you expect outperformance options on the Nikkei against
regional Asia indices and European indices to increase?
RN: I think implied vol is too high for outperformance options to be
attractive, which is why most
clients have been expressing views
“Whilst expectations of
through vanillas. The next option
continued low interest
expiry will see a lot of in-the-money
rates are driving a hunt
calls expiring, owned in many
for yield, I’m not sure
cases by international hedge funds.
But, perhaps surprisingly given
it’s yet got to the point
the size of the move we’ve had,
where we can call it a
there continues to be interest for
fully-fledged rotation.”
Nikkei upside with clients rolling call
strikes up and extending tenors.
The other effect of the recent rally is the volume of structured
products that will now knock out if we remain at these Nikkei
spot levels.
If I had to estimate the proportion of total outstanding issuance
that will knock out within the next three months I’d say it’s well over
65% These products are still being replaced at a reasonable rate
through new issuance and I expect they will continue to dominate
market dynamics.
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23
DerivativesWeek The weekly issue from Derivatives Intelligence DI: In the past, we have seen a lot of long-term variable
annuity hedging coming out of the U.S. Yet, with Solvency II,
how have you seen this type of hedging increase in Europe
from an equity derivatives perspective?
RN: It’s been a topic of discussion for quite some time, and one
that our structuring team has been engaged in. In the U.S. the
liability-hedging strategies of insurance companies have driven the
long end of the market for many years, first through variance and
then through vanilla put options. More recently the maturity of these
trades has become shorter but it’s still an enormously influential
factor in shaping the curve in the U.S. We’re nowhere near that
situation in Europe. In some ways it’s a similar story to the VSTOXX
versus the VIX—over time it will probably become more significant
but it’s a slower process than anticipated. Significantly though,
in Europe we recently facilitated several transactions whereby
insurance companies bought long-dated structured calls instead
of buying the underlying equities, which is more efficient for them
under Solvency II.
DI: There has been a lot of activity in options on emerging
market ETFs, such as Mexico vs. Brazil, for example. Is that
theme continuing in the market at present?
RN: Yes, that’s still going on. For years now there’s been decent
flow on EEM in particular, because it’s a low vol, liquid way to get
exposure to global emerging markets. We’ve seen a reasonable
amount of emerging market structured product flow recently, and
emerging market correlation products have also traded. There’s
now some liquidity in the secondary market to hedge the major
pairs, so it is possible to cover the correlation risk that you sell
through issuance of global emerging market products,
DI: Finally, what is your biggest concern in terms of
regulation?
RN: If I had to pick a single issue it would be the financial
transaction tax. A number of well-balanced research notes have
been published on the possible unintended consequences of
the FTT, but more valuable than any report is the real effect that
we’re already witnessing. In Italy where a version of the FTT
has been brought into law, single stock options have virtually
stopped trading. When pricing derivatives in a market with an
FTT there are two components to consider—the first is the tax
on the derivative transaction itself, which will be detrimental to
the liquidity of that market.
This would be a devastating problem for high-volume markets
such as repo, but for long-dated and relatively low volume products
a one-off tax would not necessarily make the product economically
unviable. However, if market-makers are subject to the tax every
time they buy or sell stock to dynamically hedge gamma through
the life of the trade, this will have the effect of widening the bid/
offer spread significantly which in turn could make the product
completely unviable. It remains to be seen how the implementation
of the FTT will play out, but in its current form I would expect it to
be prohibitive for a lot of flow businesses.
24 www.derivativesintelligence.com
CS In Best (Continued from page 1)
“[In] the multi-bonus certificates, if you hit the barrier you get the
worst-of. If you don’t hit the barrier you get the bonus level (100%) or
if better, the basket performance. The difference is now that, instead
of having a bonus of 10, 20, 30%, or whatever, you invest in a best-of
call which leads to the performance of the best-of if no barrier has
been touched,” Thomas Schmidlin, head of equity derivative sales,
Switzerland, in Zurich, told DI. “The big difference is if you have not
touched the barrier and the performance of one of the shares is
positive, you get the performance of the best. So if ABB is +5, Zurich
is -10 and Nestlé is +20, you get 20% on top of your notional.”
The certificates, which mature May 13, 2015, are not capital
protected. The underlying shares in the certificates have a barrier
level of 65%, meaning one share must fall by more than 35% from
its initial level for an investor’s capital to subject to a potential loss.
The best-of bonus certificate is the latest innovation in structured
products in Switzerland, which has seen the launch of structures
such as full participation reverse convertible structured products
(DI, 11/1), and collateral-secured instrument structured products,
which have subsequently grown in popularity throughout Europe.
Schmidlin added that the new offering from Credit Suisse fills
a gap in the structured products market. “For example—from an
investors point of view as to why you might be interested in this—I
once had a discussion with an investor, he was very bullish on
financials and he didn’t know which financial share to choose,”
he noted. “So in this case, I would definitely say now, ‘Why don’t
you invest in a best-of bonus certificate, as you can then get the
performance of the best of a selection of financial shares.’”
—Rob McGlinchey
Events
• The International Swaps and Derivatives Association will hold
a conference on implementing E.U. derivatives regulation on May
14 at its headquarters in London. Topics will include implementing
the European Market Infrastructure Regulation clearing obligation,
non-cleared trades, and potential ISDA documentation implications
of EMIR compliance.
• Futures and Options World will host its fifth Derivatives World
Latin America conference on June 5 at the Grand Hyatt in São
Paulo. The cross-asset focus of the conference will cover areas
such as challenges posed by the fall in interest rates in Brazil, in
addition to trends and new product launches in the region. For
further information, visit www.fowevents.com.
Quote of the Week
“While the growth rate has been impressive, it’s still got a very long
way to go before it becomes anywhere near the scale of the VIX.”—
Roger Naylor, head of global equity derivatives at UBS in London,
on the Vstoxx following increased volume in mini-futures and
options on the index over the last few years (see Q&A, page 23).
© Institutional Investor, LLC 2013
VOL. XXII, NO. 16 / April 22, 2013