Steadying the ship
In the world of derivatives market-making, sustainability and consistency are closely linked. A business that is not run sustainably will, in the end, be inconsistent: it will widen its spreads, cut clients or retreat from some products.
This year’s awards provided numerous examples of firms seeking to achieve both – to steady the ship after years of regulatory and pricing upheaval.
At Societe Generale Corporate & Investment Banking (SG CIB), the run-up to the UK’s referendum on EU membership was accompanied by a set of unusually specific instructions from senior management and the board: “[They] were not keen on losing a large amount of money on this day, or making a large amount of money. They were focused on being insensitive to event risk,” says Bruno Gaussorgues, the bank’s global head of market risk.
SG CIB responded by tailoring stress tests to the event, taking into account some unusual specificities – the fact that the vote took place soon after the quarterly expiry of Euro Stoxx options, for example.
This prompted it to reduce negative gamma positions in forex and interest rates, so it could go into the event with the ability to provide liquidity.
It also sought to make its autocallable products business more resilient. Recent years have seen dealers frantically switching the issuance tap on and off as underlying indexes have tumbled, forcing simultaneous re-hedging of bank portfolios. Last year, SG CIB responded with a tool that tests the book’s resilience to stress, forcing it to behave more conservatively.
Sustainability was also a big aim for the equity derivatives business at Bank of America Merrill Lynch (BAML) last year. As it ramped up issuance of retail products in a bid to outmuscle retreating rivals, it built up the usual array of exotic exposures. In the past, traders might have been happy to warehouse such positions, but BAML has built its franchise on repackaging exposures and selling them on to investors.
Products that accurately mimic the underlying exposures from dealers’ structured products books are in short supply, but BAML invented a new one in late 2015, allowing it to quickly hedge 50% of its Korean autocallable book by selling clips to institutional investors, and freeing it up to keep writing new business.
Sustainability is a familiar theme for this year’s lifetime achievement award winner, Yann Gérardin. He built the equity options desk from scratch at Banque Nationale de Paris in the 1980s, and had turned BNP Paribas into one of the leading equity derivatives franchises in the world by 2008. When the crisis struck, Gérardin realised earlier than many of his peers the business model would have to change, as regulators piled on new capital requirements for market risk.
He cut the business’s balance sheet and funding usage, and, by 2012, was ready to begin taking market share again just when other banks were exiting the equity derivatives business.
In the rates market, where the derivatives world’s leviathans need to execute huge, regular flows as well as one-off jumbo trades, clients prize consistency but have not always been able to find it.
Citi and Goldman Sachs were both lauded for their reliability here, with Citi becoming Risk’s derivatives house of the year for the second time in succession, while Goldman was named the top rates house.
Calmness and consistency were attributes LCH, this year’s clearing house of the year, wore as a badge of pride in 2016. Following the UK’s shock vote to leave the EU, the central counterparty (CCP) refused to expose its members to undue risk by extending credit or permitting the ad hoc netting of client margin calls, as other CCPs chose to.
This year’s quant of the year, Jean-Philippe Bouchaud, has also made a career out of doing things the hard way, eschewing popular finance theory and immersing himself in hard data to get a real-world view. “Many economic theories – such as the principle of efficient markets – seem to be more inspired by some kind of underlying political agenda than a strict understanding of what is going on in the markets.
Similarly, a lot of models used in mathematical finance seem to be more driven by their convenience and the possibility to answer a question with a number, rather than taking the time and thinking about the problem,” he says.