Weekly Roundup | 26th October 2014
Recent news headlines indicate that the markets are still assessing the impact and implications of the high volatility day on October 15. Some hedge funds managers blamed regulations for exacerbating the volatility by limiting banks’ abilities to make markets. Some of the large dealer dark pools asked customers to temporarily trade elsewhere in the highest volatility periods. Meanwhile Wall Street dealers shed 68 percent of their junk bond exposure that week. A hodgepodge of other issues are making news as well, ranging from the release of ICE’s proposed plans for reforming the Libor rate calculations to a new electronic market maker start-up that is being created largely by employees who were cut when Bank of America shuttered its electronic market making unit earlier this year. Look below for these stories and more.
Dodd-Frank, capital requirements blamed for market volatility
Some hedge fund managers blamed last week’s volatility partially on post-financial crisis regulations. Higher capital requirements, and the Dodd-Frank Act’s Volcker Rule, which has curbed banks’ proprietary trading, have limited banks’ ability to make markets, they said. OTC Partners has been advising clients since the market volatility spiked that the pull-back in equities was due to a combination of profit-taking and higher collateral demands. Former Federal Reserve chairman Paul Volcker, for whom the Volcker Rule is named, sees it differently, suggesting that there is such a thing as too much liquidity. “Traders’ and investors’ sense of an ability to sell anything instantaneously contributed to the excessive leveraging and risk-taking that led up to the crisis,” he said in an email to Bloomberg Businessweek.
OTC Markets has two-hour trading halt
A malfunction at OTC Markets Group on Oct. 17 forced a two-hour halt in trading of U.S. stocks in over-the-counter transactions. It was the third time in less than a year that a technical problem disrupted trading. OTC Markets had trouble distributing price quotes to clients, prompting the Financial Industry Regulatory Authority (FINRA) to tell the market operator to stop trading at about 11:05 a.m. Trading resumed at 1 p.m. Several other trading venues experienced trading glitches this week, including the CBOE Futures Exchange and a Bats Global Markets Inc. stock exchange. In addition, dark pools run by Goldman Sachs, Credit Suisse, and UBS temporarily told customers to trade elsewhere on Oct. 15.
Traiana launches central clearing of OTC equities
Traiana, the ICAP-owned post-trade and risk solutions provider, has launched a new service for central clearing of OTC equities trades. The company says it has already signed on large equity brokers including Credit Suisse, JPMorgan and Instinet, and the first trade using the service was completed last week. The solution, which is called Harmony CCP Connect for Equities, is currently connected to three central counterparties (CCPs) – LCH.Clearnet, EuroCCP and SIX x-clear. Moving OTC equity trades from the current bilateral settlement model to a CCP model can reduce counterparty risk, increase transparency and facilitate the move toward T+2 settlement through compression, the company says. As CCPs net transactions alongside existing on-exchange flow, settlement costs should be reduced. Traiana estimates that participants could reduce settlement costs for OTC equity trades in EMEA by up to $30 million on an annual basis.
Huge Treasury surge suggests trader didn’t do his homework
A drastic price movement in a Treasury future suggests a trader might have done his or her math wrong. The 30-year Treasury futures contract, expiring in June, began trading at 141 12/32, and traded under 145 for almost two hours before shooting up to 150. One trader, who asked not to be identified, told Bloomberg that the contract had an implied value of around 151, based on the maturity and coupon of the Treasury bond that can be delivered. The initial price of the June 30-year Treasury futures contract was priced close to the March contract price of 140 29/32, which is valued differently because of the different Treasury bonds that can be delivered under its specifications. The CME, where the contracts trade, had decided that the June 2015 contracts would be the first where a lack of underlying 30-year Treasuries would be reflected in valuing the futures. The 7.3 percent sure in the price of the June Treasury futures was unprecedented for 30-year Treasury futures, according to Bloomberg. “We are talking about a move you might see over weeks, or a month, occur in a day,” Craig Pirrong, a finance professor at the University of Houston, told Bloomberg,
Bloomberg & SWP
ICE unveils plans to reform Libor to prevent abuse
The new administrator of the London Interbank Offered Rate (Libor) unveiled its plans for standardizing methods for calculating the Libor rate to prevent abuse. Intercontinental Exchange’s ICE Benchmark Administration (IBA) became the administrator of Libor in February in the wake of investigations into alleged manipulations of the rate that have already resulted in billions in fines. In an 11-page position paper released last week, IBA announced plans to base Libor calculations on actual transactions rather than on estimates. Due to declines in unsecured borrowing since the financial crisis, banks have expanded their sources of unsecured funding to include money market funds or sovereign wealth funds, and IBA will include rates from lending transactions with these counterparties as well. Human judgment may be used to estimate rates in some tenors where activity is too low for fully transaction-based submissions, but banks should clearly flag when human judgment is being used and it should only be used as a last resort.
IBA position paper (PDF)
LME seeks hedge fund investors and plans stronger push into China
The London Metal Exchange is laying plans to attract more fund investors, including hedge funds, and to expand further into the Chinese market. To attract more fund managers who aren’t interested in hedging physical metals and want a more standardized way to trade LME contracts, the exchange is working to funnel more liquidity into one particular expiration date each month. The idea is to make it easier for fund managers to buy and sell large amounts through investing in one date per month. The exchange’s China strategy involves adding the Chinese currency as collateral for clearing of metals contracts by year end. It is also expanding its network of certified metals warehouses in mainland China over the next few years. These plans come on the heels of legal victories that enabled reform of LME’s warehousing system and won LME the right take charge of London’s platinum and palladium pricing benchmarks.
Bank of America veteran and former head of Knight Capital Group form new electronic market maker
A Bank of America executive has brought several former BofA traders as well as a former head of Knight Capital Group on board of a new electronic market-making startup. Gene Reilly, who had been Bank of America’s head of global electronic market-making until the firm shut the unit earlier this year, is seeking $150 million in funding to recreate the business in a new company called Arxis Capital. Reilly will serve as CEO and he is being joined in the effort by former Knight Capital Group chief Tom Joyce, who came on board as executive chairman of Arxis in August. More than half a dozen former BofA employees whose jobs were eliminated when the company folded its electronic market making unit have been recruited to join the new company, including Jonathan Wang, former head of trading for the Bank of America market maker, who will run trading at Arxis, and Marlon Abayan, a former quantitative trader who is Arxis’s head of equity research.
Wall Street dealers shed 68 percent of junk bond exposure
Wall Street bond dealers slashed their net high-yield bond holdings by 68 percent in the week ended Oct. 15. The 22 primary dealers that trade with the Federal Reserve cut their positions by about $4.3 billion to a net $2 billion, according to Fed data. The cuts came during a week that saw the largest surge in volatility in more than a year. The dealers had a net $8 billion of high-yield bonds as recently as Sept. 24, and the current holdings are the lowest in data that goes back to April 2013, when the Fed changed the way it reported the information, according to the Fed data.