The blueprint behind a derivatives trading desk

As global head of trading, Fabien Oreve, has ensured that derivatives trading is a team effort at Candriam Investors Group, giving his desk all the tools and knowledge they need to trade a variety of listed and OTC products. He outlines Candriam’s use of derivatives and discusses regulatory changes, broker relationships and why the market is so volatile.

As global head of trading, Fabien Oreve, has ensured that derivatives trading is a team effort at Candriam Investors Group, giving his desk all the tools and knowledge they need to trade a variety of listed and OTC products. He outlines Candriam’s use of derivatives and discusses regulatory changes, broker relationships and why the market is so volatile.

How does your morning start at work? With a coffee? Breakfast? Emails? 

Everyone is looking for a way to perk up as they step into the office, and Candriam Investment Group’s global head of trading, Fabien Oreve, believes he has found just the thing to kick-start his trading team in the mornings.

“To start a day there is nothing better than derivatives to make a desk lively and working together,” he explains. “Team spirit is built from the beginning of the day and derivatives is the main starter for that.”

Derivatives plays a major part in the daily activities of the trading team at Candriam Investors Group, and it starts first thing in the morning.

The pan-European asset manager has €91 billion of assets under management and has people on the ground in Paris, Luxembourg and Brussels, where you will find Oreve and his team.

They trade a range of listed derivatives, including European equity, index and US Treasury futures across their different funds and Oreve has ensured that the responsibility does not fall with one trader, but the whole team. We caught up with Oreve in Brussels to get a detailed insight into the workings a buy-side derivatives trading desk.

How does your team approach derivatives trading?

Some years ago, our firm decided to make our trading desk truly multi-asset using one order management system, for all large asset classes including derivatives.

This was a strong decision taken at a time when traditional buy-side trading desks weren’t that way. When I read recent articles about some of our peers on the continent, we are seeing our model replicated by other asset managers and we are very proud of it.

How is the workload split up, do you have certain traders solely responsible for derivatives trading?

Our trading desk has been in charge of listed futures since 2011 and currency forwards and swaps for long-only funds since 2013. Derivatives orders are managed on the trading desk with two separate blotters in the same multi-asset OMS. There is one for listed-futures and one for FX.

Those blotters are shared by all traders on the Candriam desk. In practice, listed futures is split between the fixed-income traders and equity traders depending on the underlying asset, but FX is also split between traders according to the order source, that can be fixed income or equity portfolios.

It is important that everyone is committed and involved in the derivatives process, I think they should not be separate and have to be connected with the underlying. My part as manager is to improve knowledge and expertise, and derivatives can improve knowledge.

Why does Candriam use derivatives?

Our funds use derivatives for three reasons.

Firstly, and the most obvious reason, is for hedging portfolios. Where typically fund managers invest in derivatives to limit the downside risk, they also adjust portfolio duration, especially in the case of fixed income or they implement an options strategy in the case of asset allocation. Options strategy can be a combination of purchase of put options to reach a certain level of protection, and then simultaneously a sale of a call option to finance the protection.

The second reason is to get exposure to liquid instruments. That is a very interesting aspect from the trading desk perspective. Listed futures actually help reduce friction costs and mitigate the liquidity risk. When fund managers have to invest a new cash flow suddenly, or they have to make fast changes to the composition of the portfolio. They need futures because they can be traded with a very small cost and very small delay.

Number three is to enhance portfolio performance. Derivatives can take the form of tactical investments to take advantage of short term inefficiencies or market opportunities, or excessive market moves. Their model sends warning signals to help them make decisions.

We mainly trade highly-liquid instruments: Bund, Bobl, Schatz, BTP, OAT or US Treasuries futures for fixed-Income. For equities we trade Eurostoxx 50, FTSE100, Mini S&P or Topix index futures and for FX derivatives on G10 currencies.

Has your activity in derivatives increased considering the market volatility this summer?

Over recent months at Candriam’s trading desk, we have seen a significant increase of derivatives volumes due to higher volatility. Since the beginning of the year, those volumes have been more than double that of the same period last year. August has been our biggest month in notional terms for the listed futures traded for asset allocation strategies. August, traditionally a quieter month, not an expiry month but it has been the biggest.

How many execution and clearing brokers do you have, and how did you come to select them?

Candriam trading desk works with a cross-asset broker list for listed futures to limit the number of sell-side contacts. So it is a challenge for brokers, some present themselves as experts in equity products or equity derivatives and others in fixed income, but we ask them for coverage and expertise in all our main asset classes.

For Belgian and Luxembourg funds, we only use three executing brokers and one clearing broker, which greatly facilitates the interaction with brokers, the post-trade treatment and the relationship with the Middle-office. Two large US brokers and one European broker for diversity. We onboarded a third broker recently and the others were when I joined in 2010.

Having a limited number of brokers and single points of contact make the lives of our teams easier. On the post-trade side, derivatives are time-consuming and can sometimes create a lot of operational work.

You use a multi-asset order management system, what are the benefits of this?

There are many positive implications with a multi-asset OMS including derivatives, one being a better knowledge of interconnections between futures and underlying securities.

Futures are leading indicators, they help improve communication between traders before the cash market opens.

Before futures orders get into the OMS, they go through a constraint server. Once orders are into the OMS, they are pre-checked and transmitted to brokers via the FIX protocol, so that they are handled with high reactivity and security.

Candriam’s trading desk centralise listed futures and currency forwards and swaps, which represents the vast majority of derivatives volumes at Candriam Belgium and Luxembourg. Currently, there is a project to onboard listed options into the OMS.

What is the driver behind adding options into your OMS?

We don’t have listed options yet but there is a project to get it in an upgraded version of the OMS.

The way we have built up this desk from 2010, we have integrated assset classes and activities over time, so now we have reached a very high level of centralisation on the desk. Options is one of the few remaining activities and the plan is to coincide this new need for getting this activity on the desk and the opportunity that the OMS provider has given us to upgrade the version to facilitate a new blotter in the OMS. Options cannot be include in the listed futures blotter, so it will be the fifth of our OMS. We have cash equity, cash bonds, listed futures, FX and number five will be options. That will be hopefully finished in the coming months.

Is your trading desk predominantly more high- or low-touch focused?

On our desk, futures trading is fundamentally a high-touch business: first, we often ask our brokers to inform us about liquidity, which greatly vary depending on the instrument and moment we trade. Second, we primarily work large size orders in the market sometimes with limit prices or spreads, and monitor performance through the OMS in real-time.

From my perspective, high-touch trading is not inconsistent with highly-liquid markets, especially if order books are not as deep as they used to be.

Derivatives are sometimes criticised for increasing the volatility of the market, but actually, it’s more the high proportion of high-frequency traders in order books than derivatives that contribute to volatility spikes. That’s my conviction.

What other improvements have you made to the trading desk recently?

One of my priorities, in order to help our desk manage futures in fast-moving markets and gain efficiency, has been to install a click-and-dial telephone functionality called Cisco Jabber on the PC directly. For FX, the picture is slightly different as we mainly use a RFQ platform – Thomson Reuters FX-All – integrated into the OMS. We click next to the brokers name on the screen where we work orders and my traders are then able to click away and not worry about focusing on another system on the desk. It sounds basic and it’s not innovation but it is an example of how to standardise tools that traders have in their hands. Telephone is a funny thing we have put in, but it reduces latency, where it would take 10 seconds to place a call it now takes one. It takes away the pressure from our traders, they don’t have to dial they just point and click. This has helped complete our trading environment for listed futures.

How have you been meeting the demands of European derivatives regulation?

The European regulation for OTC derivatives [EMIR] has taken us quite a while to prepare for. The three pillars of this are trade reporting, collateral management and clearing.

For trade reporting Candriam reports instrument characteristics, daily mark-to-market valuations, collateral and sent those reports to a trade repository. We actually delegate reporting for complex derivatives – equity swaps, credit derivatives swaps, interest rate swaps, commodity swaps – but reports, currency forwards and currency swaps on their own.

There is an ongoing European Commission consultation which could lead to the same principle as Dodd-Frank, where only one side of the trade does the reporting. I think it would be good that we leave the reporting task to the sell-side.

Candriam also performs portfolio reconciliation every quarter and use a third-party software through TriOptima TriResolve in order to gain operational efficiency.

Collateral management obligations will be effective on September 2016 but Candriam will be impacted in March 2017 for variation margin on non-cleared OTC derivatives. We are working on a target solution for a collateral management tool.

For clearing, this will be later as well. Clearing obligations for vanilla swaps and interest rate swaps will start in June 2017. The next step will include credit derivatives swaps at the end of 2017 and equity swaps later on.

Candriam can rely on its US experience as the firm manages a US mandate which invests in some derivatives executed in a swap execution facility.