Back to the future
For stepping up with an ambitious plan to redefine the voice-traded world of customised swaps while maintaining its commitment to firm, tight and consistent benchmark pricing, Citadel Securities is IFR’s Interest Rate Derivatives House of the Year.
Widely credited as the disruptive force that slashed bid-offer spreads on US dollar benchmark swaps, Citadel Securities could easily have become a victim of its own success. Banks fought back with a vengeance, upgrading technology and partnering with electronic trading specialists to close the gap on their new rival.
Fighting to maintain a top-five position in dollar benchmarks and watching a peak 20% market share on the largest swap execution facility erode to 12%, the electronic execution specialist stepped out of its comfort zone and picked up the phone.
Voice trading was the next avenue to unleash innovation as the firm spied a liquidity gap in customised swaps – a mainstay for insurance companies to accurately hedge their liabilities.
“We had to build on what we created, otherwise we would have stagnated,” said Paul Hamill, global head of FICC at Citadel Securities.
“Our customers wanted to give us more business, but they wanted us to be more relevant in a broader sense of the product. If we can only service a client on 20% of their business – and by definition we’ve made that business more commoditised, liquid and transparent – it’s harder to see where the edge is.”
For a firm that embraced algo pricing and auto-hedging to undercut incumbents, a move to higher-touch custom business – where pricing can be more art than science – was a culture shift. The first step was to attract top trading talent from the very institutions that Citadel had leapfrogged two years earlier.
The market-maker hired Daniel Gottlander, a top rates trader from Citigroup, to head the swaps business. A parallel effort to expand the Treasuries platform to off-the-run securities saw Michael de Pass join from Bank of America Merrill Lynch to head that operation. It was a team that won approving nods from clients.
“Citadel seems to be the leader in terms of technology and the people it brings on board,” said a rates trading head at a Middle East bank client. “The service is good, the team is very personable and pricing is consistently top three.”
For derivatives that stray from standard terms, there is no stream of firm prices – a key differentiator for Citadel in its benchmark activities – but the company believes it has an edge, turning around quotes with multiple variations in seconds rather than minutes.
“How we think about swaps pricing is that we don’t want to have the client send an enquiry and we go away and price it. We want to know the price,” said Hamill. “We want to have all the data so that the experience of trading a custom swap is broadly the same experience of trading a benchmark swap with us. That’s something our competitors don’t do.”
The expansion paid dividends as the institutional client roster doubled in 12 months, reaching almost 900 by October. In addition to insurers seeking custom swaps liquidity, the firm added its first central bank clients and had big wins with pension plans across the US and Canada.
“They’ve been really proactive in trying to meet the needs of clients,” said a portfolio manager at a large global hedge fund. “I don’t know how long it takes to get real traction [in custom swaps], but I think they will end up being one of the biggest.”
In Europe, where regional banks stepped up to fill a liquidity gap in euro swaps, Citadel expanded its partnerships with those players, providing dollar liquidity as they expanded their operations.
Despite setting its sights on new prizes, Citadel’s commitment to the electronic benchmark business was unfaltering. The firm streams live executable prices across 1,400 swaps, in all market conditions, and remains the only dealer to guarantee firm pricing.
“Banks have caught up and got better, but Citadel is still consistently top three and gets a good share of our business,” said a portfolio manager at a systematic fund that trades hundreds of swaps each month.
The Citadel service may not come with the bells and whistles of a bank powerhouse – research, advisory and structuring – but for an increasing number of investors who bring their own intellectual property to the table, the approach can be advantageous.
“Their approach is the best in terms of client service,” said the systematic trader. “They’ve been developing the sales force and it’s the right balance of being mostly really good at pricing, and having people on the phone who can provide colour, but they don’t overwhelm you with it.”
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