Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

It took just four months for Citadel Securities to become a significant dealer in a $25 billion-a-day credit-derivatives market.

This is an impressive feat for any firm entering an industry. But it’s especially remarkable given that this derivatives market, for U.S. credit-swap indexes, was once among the more lucrative and competitive on Wall Street.

Here are two ways to look at this:

1) Citadel has quickly muscled its way onto the turf of big Wall Street banks with a leaner, more technologically savvy team.

2) The firm has helped create a new version of the credit-swap trading business in an environment that is much less profitable for big banks.

Both views are correct. Citadel is winning business by offering clients the ability to trade derivatives faster and more cheaply than they can elsewhere. That means Citadel can get paid less per trade than big banks do, which is a model that works better for a privately owned firm that isn’t hindered by massive overhead, legacy costs and return-on-equity demands.

As a result, Citadel is quickly amassing a slew of clients. Since April, the firm has traded more than $116 billion of these credit-swap index contracts, or almost 12 percent of total trading, Bloomberg News reported Thursday.

This is more than just an opportunistic move by Citadel Securities, which is a separate business from Citadel the hedge fund. The dealer has been angling to create a more equity-like structure for credit derivatives for almost a decade. Years ago, it came up against so much opposition from big banks that the issue led to a lawsuit and antitrust investigations.

But times have changed. A ban on proprietary trading and mandatory trading for some securities through clearinghouses has made the business much less lucrative for large banks. While the banks still trade these indexed derivatives contracts for their clients, the business is generally treated more like a service and not a profit center. There's just too much risk involved for not enough profit. And the credit-derivatives market looks much different than it did a few years back, requiring a significant technological investment. 

To give a sense of how swift this market’s transformation has been, consider this: Less than 50 percent of credit-default swap indexes were traded on electronic platforms known as swap-execution facilities in the first three months of 2014, compared with almost 80 percent of such trades in the three months ended June 30, according to data compiled by the International Swaps and Derivatives Association.

Split Roads
There's been a rapid rise of credit-default swap indexes traded electronically in recent years
Source: ISDA
Average daily trading volumes of credit-default swap indexes

The more Citadel succeeds, the more credit-swap indexes will look like stocks, which trade quickly in small increments. That’s already happening, with trade sizes declining 7.2 percent in the second quarter of 2016 compared with those in the period a year earlier, ISDA data show.

Meanwhile, Citadel is committing its own money to facilitate the derivatives trading, in contrast to big banks, which are cutting their inventories. It has plans to start trading European credit-default swap indexes and hopes to also trade credit-default swaps tied to individual companies at some point.

The transformation of the derivatives business will have profound effects on the infrastructure of markets in years to come. Citadel has been planning it for years, and it is now finally putting its vision into action.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net