Derivatives House and Credit Derivatives House: Citigroup

IFR Review of the Year 2015
8 min read
, Helen Bartholomew

Doing it all

As intensified regulatory pressure pushes more banks to restructure, those that took their medicine early had the chance to tally significant gains. For taking advantage of being ahead of the curve, and cementing its position as a global full-service provider, Citigroup is both IFR’s Derivatives House and Credit Derivatives House of the Year.

Stringent new capital and leverage requirements were enough to get most of the last derivatives stalwarts to abandon their global ambitions this year – and get serious about restructuring their businesses.

But Citigroup had been an early mover. It had hived off US$850bn of toxic assets into a non-core unit in 2009, which helped leave the banking giant in solid shape as new regulations kicked in. The bank boasted a Basel III Tier 1 Common Ratio of 11.6% by September 2015, up from 10.6% a year previously. Its Supplementary Leverage Ratio was 6.8%, up from 6% a year previously, while the markets business generated return on equity of almost 20%.

And with a superior capital position – and a presence in 100 countries – this has been the time to take advantage.

“We’re better positioned than any of our biggest competitors to pursue a global strategy, and that gives us an advantage in future growth opportunities,” said Paco Ybarra, global head of markets and securities services.

“To be a full-service house you have to be profitable at all levels, and we have achieved that,” he said. “There’s no big product group that’s unprofitable for us, and that wasn’t true a few years ago.”

In fact, while the bank struggled to break into the top 10 of the league tables before the financial crisis, Citigroup saw fixed income generate US$9.1bn of revenue in the first three quarters of 2015.

And it seemed to find profitable avenues in every corner of the business.

“We don’t talk about derivatives on their own, we talk about solutions for the new market environment,” said Leonardo Arduini, markets head for EMEA. “If you can’t find a solution for zero rates with a structured note, that’s where an engine like Citi comes in.”

Citigroup homed in on cross-currency swaps to answer the call for yield by swapping higher overseas rates into US dollars and euros. Not yet cleared, the products became expensive from a capital perspective. But by transacting with asset managers that had cash CSAs in place, the instruments became viable for the bank.

Large transactions included a US$1bn asset swap on five-year Japanese government bonds ahead of an auction, requiring Citigroup to bear some risk in securing them.

“For our top clients we are number one or two for the expertise that we bring,” said Huy Nguyen Trieu, the bank’s head of macro structuring. “Content is crucial – and that has been one of the main changes for Citi.”

A new analytics platform, Yield Hub, enabled clients to compare yields, and more than 500 customers used it in the two months after its soft launch in October.

The application sits on a platform that was enhanced with G10 rates, spread trading and improved futures coverage.

In the clear

Citigroup was also able to translate its capital and leverage strength into a leading position in OTC clearing, which was central to client discussions.

With US$6.46bn of segregated client funds backing cleared swap trades at the end of the third quarter, the bank maintained a top four position with a model that was profitable due to its scale and efficiency.

“Clearing is a huge part of the derivatives and risk-taking business and a core part of the strategy,” said Chris Perkins, global head of derivatives clearing.

“Clearing is the tie that binds us,” said Perkins. “If you want a strong fixed-income business and you don’t have clearing, you can’t trade with clients. It’s such an important part of the derivatives business.”

Citigroup has also been going against the tide to rebuild its commodities business while other dealers have exited in droves – and that strategic decision paid significant dividends in 2015.

“We didn’t want to leave the room when the commodity conversation came up with clients,” said Ybarra. “We’re very selective on what we do and who we do it with, but we don’t want to be absent from any business area.”

After doubling revenues in 2014, the commodity division went on to grow by a further 25% in 2015, putting Citigroup in the top tier.

“We’ve always been there trading underlyings, but what we didn’t have was a strategy to bring it together with other parts of the bank,” said Jose Cogolludo, global head of commodity sales.

For example, the bank bought electricity 14 years out from one wind farm and was able to match the exposure with Facebook, which has long-term electricity requirements at its data centres.

Citigroup also participated as a joint counterparty on some of the biggest sovereign hedging programmes. It was sole counterparty on a US$20bn oil hedge for the Government of Jamaica, for example.

Equity trading also put in a stellar performance, with revenue climbing 10% in the first three quarters to US$2.5bn. The derivatives team was rebuilt, following a series of senior departures, while the trading platform was overhauled.

“It has been a year of common sense: we increased P&L and reduced our P&L volatility,” said David Haldane, head of EMEA equity derivatives.

“We have been smart in the way we deployed capital. We’ve developed a new set of volatility signals between flow and exotics, and are more systematic in overall risk on the desk.”

Full credit

In the credit space, Citigroup proved its mettle by committing to operating a full product shop, even as others backed away.

Drawing plaudits for its reliability in indexes, single names, options and structured products, the bank showed it was prepared to swallow a punitive regulatory capital environment to maintain a diverse menu of solutions.

“We felt our clients would be best served by not trying to pick and choose according to demand in any single timeframe,” said Mickey Bhatia, head of structured credit. “We have brought in the right people and invested in our technology platform to reflect our focus on growing the business.”

The bank also distinguished itself in bespoke collateralised synthetic obligations, accounting for nearly half the market by selling around US$10bn on a full capital structure basis. To place the entire structure, Citigroup was confident enough to offer leverage on senior tranches.

“Real money investors have become more comfortable with the synthetic product,” said Bhatia. “We are happy to offer the senior on a leveraged basis, but the maturities are shorter than pre-crisis and the structures are full recourse to the investor.”

Citigroup was a market leader in 2015 in credit index trading, posting volumes in the 10 months to the end of October of around US$1.3trn, an increase of 135% compared with the same period in 2014.

The bank also averaged a nearly 11% market share in the top 20 US investment-grade single names over 2014 and 2015. In aggregate, it traded nearly US$65bn in investment-grade CDS from January to late October.

“Investment-grade has come back strongly, fuelled by idiosyncratic stories like Volkswagen,” said James Duffy, the bank’s head of single-name trading. “We took a large proportion of that business and managed to do so at a consistent bid-offer spread.”

In the first week after revelations of emissions test cheating, Citigroup executed US$1.7bn of Volkswagen trades, compared with US$4bn recorded by the DTCC.

The bank was one of few dealers capable of running a high-speed CDS index trading business, effecting quote generation, distribution, execution and hedging through its Auto Market Making programme. Yet again, when a crisis emerged, the bank found itself in position to make the most of the situation.

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Derivatives House and Credit Derivatives House: Citigroup cartoon
Derivatives House and Credit Derivatives House: Citigroup