Interest Rate Derivatives House: Citadel Securities
As trading of standardised swaps became established on mandated electronic venues and banks came under increased capital pressures, opportunities emerged for alternative liquidity providers. For understanding the importance of price and efficiency, and establishing a paradigm for how swaps markets may operate in the future, Citadel Securities is IFR’s Interest Rate Derivatives House of the Year.
Citadel Securities has taken the US interest rate swap market by storm since its launch in November 2014, in the process demonstrating a unique understanding of the regulatory landscape and the rising importance of value for money.
As swathes of the US interest rate swap market moved to central clearing, Citadel became the first non-bank to establish itself as a credible alternative liquidity provider, often surpassing the competition on price and speed.
Its winning formula comprised a commitment to reliability, evidenced by consistently impressive performance in periods of volatility, and an ability to undercut its rivals across ticket sizes and tenors.
“Customers are becoming accustomed to trading on screen and processing through central clearing counterparties, which are game-changers in terms of how the market works,” said Paul Hamill, Citadel’s global head of fixed income, currencies and commodities.
“We are not a bank and we don’t behave like a bank. We don’t provide research or high-touch sales, and that has helped us differentiate ourselves from the competition.”
Regulated trading of standardised over-the-counter rates derivatives was mandated under the US Dodd-Frank Act in February 2014, forcing the migration of trillions of dollars of swaps into so-called swap execution facilities and central clearing.
At the same time, soaring capital requirements prompted some banks and futures commission merchants to cut client lists or withdraw from derivatives markets. That created an opportunity and Citadel took full advantage, becoming number one in execution market share on the leading trading venue within a few months of launching.
The company also initiated self-clearing, signing up as a member of LCH.Clearnet’s SwapClear this October, and becoming the first non-bank to do so.
In building its interest rates swap platform, Citadel used its experience in futures market-making to create efficiencies and offer the lowest possible trading price. It quotes bid-ask spreads between 0.2bp and 0.25bp for 10-year US dollar interest rates swaps on sizes up to US$60m, rising to 0.3bp for larger trades. The average comparable bank bid-ask spread is 0.4bp to 0.5bp, it says.
Market depth – the amount a client can trade without moving the bid-offer – is optimised in real time through sophisticated quoting algorithms, backed by a multi-factor pricing engine that adjusts in sub-seconds post-execution.
“We don’t quote a price and then decide how to hedge,” said Hamill “When we quote the price we know what the impact will be from a risk management standpoint, aiming to be competitive at every trade size.”
According to its own estimates, Citadel is a top-three dealer of US interest rates swaps on the largest venue, measured by inquiry shown, and has been consistently in the top five in terms of risk traded in volatile markets.
“To stream live and continuously we must be absolutely certain about the quality of our pricing at all times, and in all conditions,” said Hamill. “Our model begins with the concept of auto-quoting, auto-responding and auto-hedging.”
Citadel streams live executable prices for trades up to US$100,000 in DV01, and guarantees a quote up to US$700,000 in DV01. The company’s hit-ratio is 47.4%, a metric Hamill says is “by far the best on the Street”, while its average response time is 0.36 seconds, compared with an industry average of five seconds.
“Even if someone sends us a request-for-quote, we are sending back a live price, and we are always the fastest to respond,” said Hamill. “The price you see on the screen is the one you can execute at, and that is the differentiator for us against our competitors.”
By focusing on price and speed, backed up by cutting-edge hedging algorithms, Citadel broke the mould for market-making in the US$435trn interest rate derivatives market, and opened the door for new liquidity providers in the dominant rates derivative asset class.
In a short space of time it has become a major player in flow markets and the benchmark for pricing and speed by which others are judged.