Photographer: Stefen Chow/Bloomberg

Using Chinese Money, a Hedge-Fund Startup Bets Big in Treasuries

  • Citic Capital backs ex-Greenwich trader on relative-value fund
  • Firm enlists ICBC for leverage as banks retreat from repos

Tucked alongside the rumbling I-95 highway overpass that spans the Norwalk River in Connecticut, about an hour’s drive from Manhattan, is a small office building in the distinctive shape of an octagram.

Inside, you’ll find the usual hodgepodge of homegrown businesses: a marine-parts supplier, a local newspaper, a U-Haul rental facility, and so on. But up on the third floor, in suite 3G, one of China’s financial heavyweights has quietly teamed up with a star Wall Street bond trader to make big bets in the U.S. Treasury market.

The outfit goes by the somewhat unwieldy name of CCSZF Management. The firm is backed by a Citic Group unit, which supplied the seed money, while Industrial & Commercial Bank of China Ltd. was brought in to provide financing in return for a cut of the profits. The key man behind it all is Stephen Siu, who spent two decades helping to pioneer arbitrage strategies for Treasuries on the proprietary trading desk at Greenwich Capital Markets, which later became part of Royal Bank of Scotland Group Plc. Former colleagues describe Siu as one of the savviest traders around, with a keen eye for exploiting minuscule price gaps between the bond and futures markets.

“He is the real deal,” said David Ader, who worked with Siu at Greenwich in the mid-2000s and has been the top-ranked U.S. rates strategist in Institutional Investor’s annual survey for 11 straight years.

Changing Landscape

The new firm’s modest digs might not look like much to the tony hedge-fund set in Greenwich or Westport. But in some ways, the story of Siu and his Chinese financiers speaks to how post-crisis regulations designed to limit risk-taking have fundamentally altered the landscape in the $13.5 trillion market for Treasuries to an extent that few could have anticipated. What’s more, it reflects yet another way that China’s financial clout is making itself apparent in the most important debt market in the world.

CCSZF’s business model underscores two particular changes, which have created greater arbitrage opportunities in Treasuries, while at the same time limiting the number of traders who can pursue them. The first is the rise of futures trading as bouts of bond-market illiquidity increase. The second has to do with access to financing and the fact that fewer banks are providing it.

For a QuickTake explainer on leverage and capital requirements, click here.

CCSZF combines the name of Citic Capital, an asset manager for one of China’s largest state investment companies, with the last names of its three main partners -- Siu, Jim Zhao and Christian Fox -- all Greenwich alums who also own minority stakes in the firm.

Siu’s connection to Citic Capital, which provided $45 million of CCSZF’s $50 million in capital, is through Chief Executive Officer Yichen Zhang. Both went to MIT before joining Greenwich Capital in 1987. And after a brief stint at Brevan Howard Asset Management, Siu ran a firm called Westport Trading Partners.

Siu declined to comment, as did representatives for Citic Capital and ICBC.

Liquidity Worries

The 59-year-old trader and Citic are joining forces at a time when the market for Treasuries, long considered the deepest and most-liquid in the world, has become increasingly hard to navigate. As the Dodd-Frank Act leads the big U.S. banks to retreat from the business of lending and trading Treasuries, more investors have voiced concern that liquidity has become less predictable.

That’s spurred a move into futures, which don’t require the large sums of money upfront and also trade electronically.

“As balance sheet becomes more of a problem, people are buying futures instead,” said Howard Finkel, who has spent 25 years working as relative-value trader for Treasuries, including stints at Millennium Partners and BTIG.

Trading in the contracts, which give the buyer the right to purchase Treasuries at a set price on a future date, has ballooned to equal 77 percent of cash volumes, from 59 percent in 2012, according to CME Group Inc.

That demand has caused the contracts to trade at a premium relative to the underlying bonds. It’s exactly those “different supply and demand dynamics” that CCSZF seeks to profit from, according to a July regulatory filing. Typically, funds can do so by buying the bond and shorting the futures to lock in gains when the contract expires and prices converge.

Price Discrepancies

But because the price discrepancies traders seek to arbitrage are so small, perhaps only 1/10th of a percentage point, firms like CCSZF typically try to juice returns by borrowing money through repurchase agreements -- with sums reaching $60 for each dollar of invested capital in some cases. For CCSZF, that type of leverage would boost its assets under management to $3 billion.

If you can get financing, it’s easier to “step in and pick up some of these coins you find on the sidewalk,” said Stuart Sparks, an interest-rate strategist at Deutsche Bank AG.

To increase its leverage, CCSZF is turning to ICBC -- and for good reason.

In the post-crisis world, ICBC has become a big player in repo financing as Dodd-Frank makes it costly for U.S. banks to compete. While ICBC is the world’s largest bank by assets, the enhanced capital requirements that have made it prohibitively expensive for major U.S. firms to provide repo financing apply only to its local units. And because their combined assets fall below the $50 billion threshold where those extra costs kick in, ICBC has the flexibility to offer far more competitive terms than its American rivals.

Repo Financing

ICBC Financial Services, the bank’s brokerage unit, provided about $88 billion of repo financing at the end of 2015, up from $59 billion two years ago, according to regulatory filings. The figures are before netting agreements that can be used to reduce overall assets and liabilities. Almost all the repo financing that ICBC provides is on U.S. government bonds.

“Everybody uses” ICBC for repo financing now, said Will Heins, an independent consultant and former interest-rate derivatives broker at Javelin Capital Markets. “They’re cheaper than everybody else.”

And in an era of rock-bottom interest rates, a key to Siu’s and CCSZF’s success may just hinge on getting the lowest possible repo rate.

These days, “most of the relative-value trading between cash and futures is focused upon, ‘What interest rate can I borrow the bond at?” said Pacific Investment Management Co.’s Harley Bassman, who created the widely followed rate volatility gauge called the MOVE index.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE