UBS Neo: OTC trading platform of the year

Risk.net January 2015

RISK MANAGEMENT • DERIVATIVES • REGULATION

Reprinted from

Awards: Introduction

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Big portfolio disposals, baffling market moves, hedge funds making hay while others lost a fortune, balletic risk management, the recovery of eurozone fallen angels – for a year that was relatively quiet during its first nine months, 2014 eventually managed to generate a fair amount of drama.

Arguably the biggest story for risk managers, traders and investors was the huge intraday swing in US Treasuries on October 15, and the forces that provoked it. Press reports initially blamed it on electronic trading and thin dealer inventories, but Risk later pieced together a more complex tale of hedge fund crowding (Risk December 2014, www.risk.net/2384515).

At the time, confusion reined, but it was a defining moment for a number of this year’s Risk award winners.

At Deutsche Bank, October 15 kicked off with an all-hands-on-deck meeting of senior traders and risk managers after a bank-wide value-at-risk limit was hit. A decision to slash exposure was taken quickly. The plan was communicated to Deutsche’s board and the next day-and-a-half saw the bank shed roughly a third of its risk, as measured by VAR.

“In my 18 years at the bank, I have never seen such a single-minded approach to take risk down so dramatically when called to do so,” says Stuart Lewis, the bank’s chief risk officer.

Elsewhere, the burst of volatility and risk aversion became an opportunity. Napier Park Global Capital had been cautious for a while, viewing credit default swap (CDS) spreads as too narrow. The credit fund ventured into equity markets to execute a well-timed macro hedge in late August, and was positioned perfectly for the panic that would later hit CDS markets as spreads widened – October 14 was “one of our biggest buying days,” says James O’Brien, the fund’s chief executive.

In the old days, Napier Park would have had a lot more company, but O’Brien notes the field is now a lot thinner: “The banks can no longer arbitrage the mis-pricings during these sell-offs, and that’s where we can take advantage.” That highlights one of the themes of this year’s awards – the retreat of dealers, and the corresponding advance of the buy side – with a number of the write-ups documenting the blurring, shifting boundary between the two.

But while banks certainly are retreating, that story can be overdone. In reality, dealers are part-way through deciding what they want to do, and focusing on it – take Citi’s purchase of a $250 billion hedged portfolio of single-name CDSs from a European bank. Citi declined to reveal the seller, but enquiries by Risk journalists revealed it was Deutsche Bank.

While Deutsche wanted out of the non-cleared CDS market, Citi wanted in – sort of. The US bank acquired $450 billion of credit assets from various peers last year, but only because it believes it can use expertise gained while winding up its bad bank to recycle, compress or sell the assets at a gain. In the case of the Deutsche Bank portfolio, it has given itself six months to do so, and claims to be on track.

Societe Generale (SG) was also on the front foot, picking up four CDS portfolios worth €140 billion in notional from two European peers, taking on an inflation portfolio – not one of its traditional strengths – executing a big, creative longevity trade, and beginning the process of integrating Newedge into the bank. “SG has been consistent in doing what we are best at doing,” says Didier Valet, head of SG Corporate & Investment Banking. The bank wins this year’s derivatives house of the year award, and also gets the nod for equity derivatives and risk solutions.

It was not easy to pick winners. Where decisions were tight, client feedback often helped settle the issue. The Risk editorial team thanks all this year’s participants for their time and help.

Banks were asked to submit information on their business in each of the asset class and product categories during 2014, and shortlisted companies underwent face-to-face and telephone interviews. Risk then gathered feedback from clients and other market participants.

The final decisions were made by Risk’s editors and journalists, weighing a number of factors, including risk management, creativity and innovation, liquidity provision, quality of service and engagement with regulatory issues. R

A final flurry

Awards: Introduction

Derivatives house of the yearSociete Generale

Lifetime achievement awardAndrew Feldstein

Interest rate derivatives house of the yearDeutsche Bank

Currency derivatives house of the yearBNP Paribas

Equity derivatives house of the yearSociete Generale

Credit derivatives house of the yearCiti

Inflation derivatives house of the yearHSBC

Structured products house of the yearBank of America Merrill Lynch

Risk solutions house of the yearSociete Generale

OTC client clearer of the yearCiti

Deal of the yearBlackstone/Morgan Stanley

Quant of the yearMats Kjaer/Christoph Burgard

Bank risk manager of the yearDeutsche Bank

Credit portfolio manager of the yearCredit Agricole

Clearing house of the yearLCH.Clearnet

Exchange of the yearEurex

OTC infrastructure service of the yearTriOptima

Sovereign risk manager of the yearIGCP

Asset manager of the yearDoubleLine Capital

Hedge fund of the yearNapier Park Global Capital

Pension fund risk manager of the yearPKA

Corporate risk manager of the yearElectricity Supply Board of Ireland

Sef of the yearMarketAxess

OTC trading platform of the yearUBS Neo

Single-dealer platform of the yearDeutsche Bank

Law firm of the yearLinklaters

In-house system of the yearDanske Bank

Trading technology product of the year (bank)Morgan Stanley

Trading technology product of the year (vendor)Algomi

Risk management technology product of the yearIBM Risk Analytics

Back-office technology product of the yearKPMG

The roll of honour

Reprinted from Risk January 2015

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On the face of it, Neo is a single-dealer platform much like any other. Its unique selling point, and the reason it appears in this category, is its aggregation of prices from 10 swap execution facilities (Sefs).

That was always a bet on the future of the market. The service has some appeal if a large number of Sefs exist, if they all have their own rulebooks, and their own post-trade workflows – all of which is true today. It means a Neo user can access a number of Sefs via a single piece of software, which is handy (Risk June 2011, www.risk.net/2073226).

But aggregation becomes a killer app if volumes are fragmented across all of those venues, with prices for the same product varying from place to place, and lots of activity on the central limit order books (Clobs) that all Sefs are required to offer – all of which is far less true.

There may be 24 Sefs in total, but the lion’s share of the volume is going to just a handful; 94% of dealer-to-client trading is happening on Bloomberg and Tradeweb, while Sefs belonging to four interdealer brokers are seeing almost all of the trading between banks. More importantly, perhaps, clients are near-universally using request-for-quote (RFQ) trading rather than Clobs.

So UBS’s bet has so far only paid out in part. But it was a brave one. It has put the bank on the right side of many arguments about US regulation – striving to bring about change, rather than holding it back – and aligns it with the hopes many clients have for the market’s evolution. Some of them describe membership of Neo as like holding an option on change.

“In addition to Neo, we are direct members of two Sefs: TrueEx and Bloomberg. The latter is a well-functioning disclosed RFQ system that serves our index credit default swap [CDS] trading needs today, but what Neo offers is optionality for 2015. If and when the market shifts to anonymous Clob execution, I think an aggregator like Neo is a better bet than picking one or two Sefs and hoping Clob trading takes off on those platforms,” says a trader at a New York-based global asset manager.

Others are happy with the benefits the platform already offers: “We do not want direct access to Sefs because we don’t want the regulatory and legal burden of signing all of the individual Sef rulebooks and we don’t want all of our trading lines recorded, which is another regulatory requirement,” says a trader at one US regional bank.

In total, the service is understood to have signed up around 100 clients, but UBS would not share information on trading volumes.

The Sef aggregation offering grew out of the broader Neo product that was launched in 2009. As with most dealer platforms, the idea was to give clients a single hub, harnessing all of UBS’s research and e-trading tools, from foreign exchange and equities to fixed income.

Following the substantial restructuring of the bank in November 2012,

which saw a sharp reduction in both the complexity of the firm’s opera-tions and the size of its balance sheet in flow fixed-income products, Neo’s Sef aggregation business was a natural strategic addition – the offspring of an agency business that was looking to provide clients with access to over-the-counter markets without tying up lots of capital.

But while it might have been a logical move, it required the bank to confront one uncomfortable fact – the business it was building would enable clients to trade with rival dealers. That meant winning some internal battles, but the aggregation project quickly gained some big backers.

“In terms of management buy-in, it was an easy sell,” says Kevin Arnold, head of foreign exchange, rates and credit for the Americas at UBS in New York. “The businesses where UBS is strongest – cash equities and spot foreign exchange – have high levels of electronification. Our view was if we can apply the same principles to fixed-income markets and build tools to facilitate these practices, it would fit with our broader goals of reducing complexity and the amount of capital we have tied up and move towards a future state of execution services. And that comes all the way from the top of UBS.”

When the service started trading in earnest following the start of the US Sef mandate for interest rate swaps and index credit default swaps in February last year, Neo provided access to five Sefs, rising to 10 by December, with two types of trading functionality offered. Neo acts as an introducing broker for four Sefs that operate as predominantly RFQ trading venues, giving clients the ability to execute electronically or by voice, while electronically aggregating the Clob prices that are posted live in the remaining six Sefs.

Five of these venues operate interest rate swap Clobs, while the sixth is an index CDS order book. Neo users are shown all the resting bids and offers across all of the platforms.

“We have electronic connectivity to six Sefs and we are able to act as introducing broker on an additional four,” says Mike du Plessis, global head of forex, rates and credit (FRC) execution services at UBS in London. “Not all Sefs have the same level of electronic sophistication, so our path to

“If and when the market shifts to anonymous Clob execution, I think an aggregator like Neo is a better bet than picking one or two Sefs and hoping Clob trading takes off on those platforms” Trader at a New York-based global asset manager

OTC trading platform of the year

UBS Neo

Reprinted from Risk January 2015

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connect Neo electronically has taken longer on some platforms than others. For the six that have liquid electronic order books, the client is able to interact fully with those Sefs through Neo. For the additional four, a client is able to use the Neo front end to instruct our agency desks in London and New York to interact with those additional four Sefs and facilitate access on their behalf,” says du Plessis.

That is more than enough, according to the New York-based asset manager: “In terms of access to the whole market, we are seeing prices that are a fraction of a basis point wide, so I don’t miss the other Sefs that aren’t participating in Neo. I think we can be very confident that we are still getting best execution and most likely getting tighter pricing than we would have if we stayed in the bilateral world, where prices are rounded to the nearest basis point.”

Alongside traditional OTC products, the platform offers trading in the swap futures listed by Eris Exchange and CME Group, and it already had the ability to execute interest rate package trades and spread-over-Treasury trades in anticipation of the start of mandated trading in those products on November 15 – although in the end, the Commodity Futures Trading Commission (CFTC) postponed the start date.

But the service has its critics, with some saying volumes are not sufficiently fragmented to justify use of an aggregator.

“There are 25 to 30 liquidity providers in interest rates. If you look at Tradeweb, Bloomberg and MarketAxess, we all have the full set of liquidity. By aggregating Bloomberg and Tradeweb on the rates side, it’s not clear what you get: you get the same pool of liquidity, only you get it twice. We are talking about the same instrument and the same liquidity providers, so I don’t know what aggregation gets you,” said Nathan Jenner, chief operating officer for fixed-income electronic trading at Bloomberg, speaking at an industry conference in New York on November 12 (www.risk.net/2381079).

Those comments drew a sharp response from fellow panellist, Rana Chammaa, head of FRC agency trading sales for the Americas at UBS. It was not a surprise to see the two firms clashing – Risk reported earlier in 2014 that the Neo team believed Bloomberg was reluctant to have its liquidity aggregated and was placing obstacles in the way (Risk July 2014, www.risk.net/2350848).

UBS’s du Plessis says criticism based on the lack of fragmentation

ignores the different fee structures that exist among Sefs, and does not reflect the impact non-bank market-makers could have.

“It would be simplistic to characterise all of the dealers as streaming all of the same prices to all of the Sefs. Not all dealers are on all Sefs – they stream different prices to different Sefs depending on market conditions – and the mindset we are trying to adopt is that although it may be dealers streaming liquidity today, we are starting to see non-con-ventional firms streaming liquidity and we are going to see more high-frequency firms streaming liquidity and building an all-to-all market,” says du Plessis (Risk August 2014, www.risk.net/2356144).

Opponents of aggregators have tried to argue the impartial access elements of the CFTC’s Sef rules apply only to the venue’s direct members, and not to entities that want to access a Sef to aggregate its prices.

The facts are not on their side. The CFTC’s final Sef rule from June 2013 states that a Sef is required to give “impartial access to its market and market services, including any indicative quote screens or any similar pricing data displays” to any eligible contract participant (ECP) or independent software vendor (ISV), with the latter category explicitly including aggregator platforms.

UBS’s Arnold says this argument should have been settled long ago, meaning Sefs have to accept aggregation is an important and permanent part of the landscape.

“We don’t believe there is any ambiguity around impartial access. The rule is very clear that any ECP and any ISV is entitled to impartial access. The term ECP is not limited to direct members, and the term independ-ent software vendor was defined by the CFTC in the final Sef rule to specifically include aggregators,” he says.

This kind of wrangling may be complicating relationships between Neo and some Sefs, but UBS’s Chammaa predicts growing demand from clients. “I don’t think our current clients necessarily just see Neo as a platform for the future; I think they want to gain access to the other Sefs with an easier lift than having to connect directly. Some end-users that aren’t currently trading on Sef are preparing themselves for the future expansion of the number of Sef-mandated products. Other clients may be holding out because they are focused on order book trading but would like to see spreads narrow, and are waiting for that eventuality. The market is very much in flux right now,” she says. R

Left to right: Mike du-Plessis, Kevin Arnold, Rana Chammaa, Mike Ettinger, Mark Daniels

Photo: Alex Towle