Hedge fund-broker behemoth Citadel could see its share in the swaps market-making business increase, as banks continue to withdraw in response to increasing costs.
Citadel became the first buy-side shop to open a market-making business arm for swaps in 2014. Last year it then became the first non-bank member of LCH.Clearnet’s interest rate swaps clearing unit, SwapClear.
It is also currently cited as the number one market maker by volumes in the dealer-to-client swaps market by Bloomberg, and is known for quoting exceptionally thin spreads and handling very large order sizes.
Paul Hamill, global head of fixed income, currencies and commodities at Citadel Securities, says that Citadel’s appeal is based on liquidity provision and consistency.
“Our primary selling points are the things investors care most about,” he says. “We provide firm liquidity, in size, in all market conditions. Many other dealers quote indicative prices in the swap market and have reduced their appetite for size and trading in volatile markets.”
To some extent, Citadel has taken up the slack from some of the banks which have lost their appetite to provide liquidity in the derivatives market.
Hamill believes that most dealers cannot operate at the same cost levels as a Citadel, which is perhaps the more important factor these days.
“We continue to expect tough competition but banks will find it challenging to significantly reduce costs while investing to upgrade legacy technology,” says Hamill.
However, looking at the potential for more buy-side clients to step in, Hamill says that market-making is not something that everyone can do, being very different to investing and requiring different skills to portfolio management. Citadel has itself been making markets in equities since the early 2000s.
According to Kevin McPartland, head of market structure and technology advisory at Greenwich Associates, buy-side participation in swaps pricing remains relatively limited.
“Some non-bank entities do participate in the interdealer broker SEFs, but even that is limited to date,” McPartland says.
He also believes the relationship between the buy- and sell-side in the swaps market has remained strong, and has helped to keep the status quo intact.
“Trading via RFQ (request for quote) keeps that intact and most buy-siders are happy with the quality of execution,” he adds.
In addition, the introduction of SEFs may have pushed buy-siders further away from each other, according to Josh Satten, director, business consulting at Sapient Global Markets.
“Buy-sider’s have both been brought closer to each other and farther away. Previously, the market was completely bilateral and it was a rare occurrence for two buy-side clients to face each other directly. With cleared markets, buy-side clients now use FCM’s who face a CCP on their behalf. So with cleared trading, two buy-side clients would be separated by two FCM’s and a CCP.”