This time it’s different
For an asset class scarred by the financial crisis, 2017 proved to be a pivotal year as banks that had previously given up the credit derivatives ghost piled back in. For retaining its dominant position in flow, decontaminating the once-ignominious synthetic CDO and embracing the shift to passive investing, Citigroup is IFR’s Credit Derivatives House of the Year.
A scramble for yield drove credit default swap indices to record tight levels through 2017. Dealers that had retrenched were lured back as an expansion of central clearing across index and single name CDS opened the door for a more capital-efficient model.
But a dearth of volatility drove a 25% slump in volume, making for the most competitive flow environment in almost a decade. Citigroup – a credit derivatives stalwart through the lean years – was unshaken.
“In spite of that ramp-up in competition, we’ve lost little or no market share,” said Marc Pagano, head of emerging markets credit trading at Citigroup. “You see risers and fallers over the course of the year, but if you remain consistent and offer your balance sheet to clients in times of stress, that gets you a lot of play for when the market is super-competitive.”
With a 16% market share, the bank ranked number one in credit index trading on Bloomberg’s swap execution facility for the third year running. In EMEA single name CDS, Citigroup maintained a 19% share of the top 20 iTraxx Main index constituents and increased its share of the top 20 iTraxx Crossover names to 16% – a four-point jump year-on-year. In US CDS, the bank maintained a 20% share of the top 20 CDX High Yield constituents.
As part of the hunt for yield, investors descended the credit spectrum, where Citigroup’s emerging markets strength paid dividends. The bank remained one of the top market makers in EM CDS, trading US$200bn notional in the 12 months to mid-November and over US$4bn of CEEMEA local currency access derivatives.
But the big yield opportunity lay in a return to structural complexity – which few providers had added to their credit arsenal and where Citigroup dominated.
“We’ve seen meaningful pick-up in more structured and exotic trading business and 2017 is the year when investors are doing more trades with structural complexity to meet their return hurdles,” said Vikram Prasad, who heads Citigroup’s structured credit trading business.
That meant releasing from the stocks a villain of the financial crisis – the synthetic collateralised debt obligation. Citigroup led the first post-crisis synthetic CDO deal in 2014 but 2017 marked a turning point. The bank sold more than 20 transactions to institutional clients, doubling 2016 volume.
It was no return to pre-crisis excess, however. Not only does the bank place the full capital structure, including chunky and low-yielding senior tranches, deals are no longer ratings-driven.
“The nature of investors has changed completely,” said Prasad. “They used to be concerned about return relative to the rating, but now they’re concerned about the underlying risks in the transactions.”
Deals became shorter dated – typically two to three years – filling a maturity gap that could rarely be met by other credit products such as CDS, high-yield bonds or CLOs. And with no promise of secondary liquidity, deals were sold on a buy-and-hold basis.
“We want to trade with true end-counterparts that have a larger relationship,” said Prasad. “Our ideal client is one who’s trading EM, cash bonds, CDS and structured credit with us. It’s about taking a diversified book of business so we can view them as a real investor in that space.”
Citi topped the CLO league tables in Europe. It priced 19 transactions – five more than the nearest competitor - including seven new issues, six refinancing deals and six resets, giving the US bank runaway market share at over 20%.
The bank also accelerated efforts to align its business more closely with clients, viewing the shift from active to passive investment as an opportunity rather than a threat. The bank tasked credit index trading head Jay Mann with the development of its fixed income exchange-traded fund business.
“Historically, what’s been misunderstood by banks is that if you aggregate the product earnings across the full life-cycle of the transaction, it has substantial earning potential just like FX, rates or mortgages,” said Mann.
“We touch ETFs on every part of the life-cycle. We know where all the prices are, as a custody bank we can provide financing on the shares and we cover the payment and servicing component.”
The bank created more than US$3.5bn of shares in iShares iBoxx US dollar investment-grade corporate bond ETF (LQD) in the six months to October 2017, accounting for more than 40% of net creation over that period.
“We’re at a tipping point in the credit markets. There’s going to be rampant adoption of this product as it’s a more efficient way to move risk around,” said Mann. “The primary thing is that we want to be an industry leader, both in thought and in development of the fixed income product.”