Interest Rate Derivatives House
Coming together: Turmoil in the eurozone complicated an already challenging year for the rates market as it readied itself for sweeping new regulations coming into force in 2013. For leading the way in adapting to the new rules while guiding clients through a difficult trading environment, JP Morgan is IFR’s Interest Rate Derivatives House of the Year.
To see the full digital edition of the IFR Review of the Year, please click here.
The largest sovereign debt crisis in recent memory made the rates market resemble a rollercoaster ride as banks’ fixed-income revenues increasingly mirrored the macroeconomic environment, dipping violently when fears over eurozone disintegration peaked, before jerking upwards as central banks stepped in.
Even as the eurozone crisis reverberated throughout the rates world, the largest reforms in the history of the swaps market loomed. Banks were forced to adapt business models in view of Basel III, which lumps aspects of the interest rate swaps business – particularly long-dated, uncollateralised trades – with hefty funding and capital charges.
Of more immediate concern was the US Dodd-Frank Act taking effect in 2013 – swiftly followed by similar legislation in Europe – requiring all standardised swaps to be centrally cleared and electronically executed, forcing banks to bolster infrastructure and prep customers.
In a time of unprecedented upheaval, JP Morgan stood out for its work in adapting both itself and its clients to the new operating environment, without losing sight of customers’ day-to-day needs of hedging exposures and gaining access to funding.
“JP Morgan has always been one of the best liquidity providers in the derivatives markets. They rank for sure in the very first [tier]. The quality of their service is very good and has proven to be consistent over time,” said Gianfranco Marin, a senior trader with Intesa Sanpaolo in Italy.
In a year where liquidity in the swaps market remained scarce despite the profusion of cheap central bank money pumped into the system, consistent price-making and an ability to recycle risk without making waves in the market became hallmarks of JP Morgan’s rates franchise.
“Rates is by far the largest business of JP Morgan, and this is where our global presence and size helps us to recycle risk quickly and efficiently,” said Alessandro Barnaba, co-head of sales at the bank.
“In a world that is moving away from niche players, clients are moving towards dealers that can offer breadth. We feel our size, balance sheet and strong capital position have helped our client business boom from an already strong position.”
The bank’s much-touted “fortress balance sheet” remained a potent weapon. Even a botched credit derivatives trade in the firm’s chief investment office earlier in the year barely made a dent. After announcing the losses, which could end up totalling US$7.5bn, JP Morgan’s five-year CDS briefly shot to 169bp in early June (still the lowest of its peers) before settling back to 105bp in November.
JP Morgan’s fixed-income division continued all the while to register the largest revenues across the industry, with its relative lack of exposure to the eurozone periphery making its earnings less volatile.
The interest rate derivatives business alone raked in more than US$2.2bn over the first half of the year, accounting for over a quarter of total fixed-income revenues at the bank. This was achieved with a 35% return on capital under Basel III.
“It has been a transitionary year for rates and JP Morgan. Combining corporate and investment banking has been a major change in response to our clients’ needs, but also because of some impacts of the regulatory changes,” said Kemal Askar, head of European interest rate trading.
“On top of the Dodd-Frank rules, the rules related to capital will also be meaningful. The good news is we have managed to maintain our top spot in revenues in a very good year.”
As well as the merger of corporate and investment banking, the interest rates business became fully integrated with the FX business earlier in the year. This aligned risk management systems, with the rates business moving on to Athena, a pricing and risk management platform introduced in the FX business two years previously.
Athena provides traders and salespeople with a one-stop shop to price and manage the risk on much faster systems. The idea is for all derivatives booked within JP Morgan to eventually reside in the system.
“Rates and FX have a number of common elements, particularly as the rates business becomes more electronic. Athena is the embodiment of that,” said Askar.
“There are obvious synergies between the two asset classes, with a lot of our clients – both corporate and institutional – transacting in both of these markets. It was a natural extension.”
As US regulators pushed for vanilla derivatives to be traded on swap execution facilities in 2013, electronic execution became a top priority. JP Morgan consolidated its e-commerce offering in to one single client portal in the shape of JP MorganMarkets, allowing for execution across all asset classes.
It is JP Morgan’s work with customers and its ability to recycle risk across its extensive client network that best highlights the strength of its rates business.
“Interbank liquidity has actually been quite poor this year,” said Andrew Ferry, the bank’s head of swaps trading. “Keeping our breadth of footprint so that we’re not dependent on the interbank market to recycle risk has been crucial. Instead, we look to speak with clients directly.”
The bank demonstrated its prowess across the spectrum of interest rates products. One prolonged project involved helping a mid-sized broker-dealer exit its interest rate and FX derivatives market-making business with over 2,500 line items facing 60 counterparties in five different currencies.
JPM worked with a client to execute a long dated rates options strategy to hedge risks inherent in the business model arising from their historical product offering. The transaction was significant relative to normal market volumes and the dealer designed both a hedging and execution strategy to minimise market impact and transaction costs.
“The breadth of the firm’s franchise from a sales perspective was fundamental to our ability to recycle the risk away from other bank counterparties and our trading capability crucial to both warehousing part of the risk to enable an orderly hedging proces,” said Charlie Bristow, head of options trading.
The bank regularly searches opportunities to offset risk via other asset classes including credit, commodities and equities. One prominent example is the correlation risk left on bank balance sheets by providing hedges for pension funds looking to shield themselves from lower equities and falling rates.
JP Morgan was able to repackage this risk to a hedge fund that was bullish on both equities and European fixed income.
“As an institution we’re always looking for innovative ways to work across groups,” said Askar.
All the while, JP Morgan continued to lead in the regulatory space by maintaining dialogue with regulators and industry groups and educating clients on the new market landscape.
It built out a comprehensive client clearing service across all products and geographies in preparation for central clearing rules, attracting a strong client clearing pipeline driven by existing prime brokerage customers and hundreds of additional new clearing mandates.
“As a firm we have set ourselves up operationally to provide clients with the best possible service,” said Barnaba. “We now have a banking business with a common strategy and agenda, giving us the strongest franchise possible.”