Ken Griffin's Citadel Securities Is Muscling Into Credit Derivatives

  • Citadel Securities builds market share in credit derivatives
  • Broker captured 11.5% of U.S. swaps index trading since April

Ken Griffin has become impossible to ignore in the once-lucrative world of credit derivatives, where a group of Wall Street dealers long maintained a stranglehold.

After being kept on the sidelines for the past eight years, Griffin’s Citadel Securities is muscling into the market. The firm has traded more than $116 billion of credit-default swaps tied to U.S. benchmark indexes since April, according to spokesman Zia Ahmed. That’s about 11.5 percent of total trading of those contracts when compared to reported data aggregated from the Depository Trust and Clearing Corp. and Bloomberg’s swap data repository.

Ken Griffin
Ken Griffin
Photographer: Patrick T. Fallon/Bloomberg

Griffin has come a long way since the financial crisis, when dealers were accused of thwarting his plan with CME Group Inc. to create an electronic exchange that threatened their grip on the market. They called his plan half-baked and their resistance to it led to a lawsuit and anti-trust investigations that would drag on for years and culminate in banks paying a group of investors a $1.87 billion settlement.

“Citadel is successfully navigating their way to being a dealer as well as a buyside client in this market,” said Chris White, the founder of ViableMkts LLC, a strategic advisory firm focused on market structure and technology. “Their effort is meeting less resistance now, given that several major dealers settled a lawsuit accusing them of blocking attempts to innovate the market.”

New Trader

Citadel Securities has been trading swaps tied to U.S. indexes with about 175 firms, according to Ahmed. BlueBay Asset Management started trading with the firm earlier in the year, a relationship gained when former Citigroup Inc. trader Tian Zeng joined to start its credit-default swap trading business in December, according to two people familiar with the matter, who asked not to be identified because the operations are private.

Jayne Fieldhouse, a spokeswoman for BlueBay in London, declined to comment on the firm’s trading counterparties.

“This is not an easy market to enter,” said Paul Hamill, Citadel Securities’ global head of fixed income, currencies and commodities. “We’re thrilled by the reaction and plan on expanding further, including into Europe. The investor base, across the board, is feeling the impact of the banks pulling back and therefore most are willing to engage new sources of liquidity.”

European Expansion

Citadel is building its business and has hired Sylvain Lebre to start trading European credit swap benchmarks later this year, Hamill said in a phone interview. He was previously European head of credit index and options trading at Barclays Plc.

In some respects, Citadel’s recent success has been a little like crashing a house party after the police have already busted it up.

Global banking rules intended to make the financial system safer have caused a retreat from the market in recent years. The total size of the credit-default swap market has shrunk to $12 trillion from $34 trillion in October 2008, according to DTCC data.

The hot-shot traders who once made hundreds of millions of dollars trading swaps with their banks’ own money were leashed by a ban on proprietary trading. Mandatory trading through clearinghouses has also made the business less profitable as banks can’t charge as much as before.

Banks Retreat

That’s contributed to a plunge in bank revenue from fixed-income markets. Banks including Credit Suisse Group AG, Deutsche Bank AG and Morgan Stanley have reduced fixed-income trading staff and cut compensation. Deutsche Bank, once one of the biggest players, went as far as to stop trading most swaps tied to individual companies in 2014, and cut or moved as many as 10 traders a month later.

Credit Suisse continues to be active in the market and is focusing on the most liquid contracts, according to Adam Bradbery, a London-based spokesman. Spokesmen for Deutsche Bank and Morgan Stanley in London declined to comment on the banks’ credit-default swap trading activity.

Market participants are adapting to the new environment. More than 75 percent of the average daily notional trading of credit swap indexes takes place on electronic platforms known as swap execution facilities, according to the International Swaps & Derivatives Association. SEFs were created after the crisis, before which all contracts were privately negotiated. Bloomberg LP, the parent of Bloomberg News, runs a platform.

There are a net $904 billion of outstanding contracts on indexes compared with $619 billion on individual entities, according to data compiled by DTCC.

New Players

“With a focus on technology and a balance sheet to back it up, you can make a dent in the market place where 10 years ago that wasn’t the case,” said Kevin McPartland, head of market-structure research at Greenwich Associates.

Citadel isn’t the only newcomer to break into the market. Wells Fargo & Co. began trading U.S. credit swap indexes in April and Stifel Financial Corp., the St. Louis-based investment bank and brokerage, started last year, focusing on single-name contracts and less liquid indexes, according to people with knowledge of the matter. Both firms expanded into European credit swaps last month.

Representatives for Wells Fargo and Stifel declined to disclose their credit swap trading volumes.

Dealer Resistance

Citadel’s gains haven’t been easily won. As calls for market reforms heated up in 2008, Griffin sought support for his trading platform from Andrew Feldstein, the co-founder of New York-based hedge fund BlueMountain Capital Management, according to a person familiar with the meeting. Feldstein helped pioneer credit derivatives more than a decade earlier at JPMorgan Chase & Co.

BlueMountain and Citadel declined to comment on the meeting or market developments for the story.

Citadel’s plans “freaked out the banks who had to protect their stranglehold on market making,” said Joshua Satten, director of business consulting at Sapient Global Markets, who managed trade support and operations at BlueMountain at the time and later became head of OTC operations for Omnium LLC, a Citadel subsidiary. “Now attitudes have slightly changed as they’ve had no choice but to get on board with regulatory changes.”

Griffin later pitched his plan to a group of regulators and dealers at a meeting hosted by Timothy Geithner, then president of the Federal Reserve Bank of New York. Banks were skeptical, according to Athanassios Diplas, the chief risk officer at Deutsche Bank’s credit business at the time, who was in the meeting.

Early Clearing

“Griffin was proposing something that wasn’t ready from a risk-management perspective for clearing and pushing the execution component that frankly was not the need at the time,” said Diplas. “It was met with huge skepticism and criticism by all the other parties. He wasn’t taken seriously.”

Intercontinental Exchange Inc. partnered with a group of dealers including Goldman Sachs Group Inc. and Morgan Stanley and was the first to start clearing credit swaps the following year. CME dropped the swap trading platform with Citadel and sought to only clear trades.

A group of investors including the Los Angeles County Employees Retirement Association later claimed in a lawsuit that the dealers had agreed to boycott the exchange as long as Citadel was involved. Banks including Goldman Sachs, JPMorgan and Citigroup agreed to make a payment to resolve allegations from that suit, which accused them of conspiring to limit competition in the market. They didn’t admit wrongdoing.

Spokesmen for Goldman and JPMorgan and a spokeswoman for Citigroup in London declined to comment on the lawsuit.

“The banks took action to crush Citadel’s initiative with CME,” said Satten at Sapient. “They evolved and now, eight years later, they’re the most meaningful new market maker in the space.”

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