Markets

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

Rani Molla is a Bloomberg Gadfly columnist using data visualizations to cover corporations and markets. She previously worked for the Wall Street Journal.

Some Citigroup interest-rate traders are in line for some handsome bonuses this year.

A team of U.S. dollar interest-rate swaps traders generated about $300 million of revenue for the New York bank this year, Bloomberg’s Dakin Campbell reported on Thursday. The bank’s whole interest-rate group generated more than $800 million. That’s a remarkable amount when banks are increasingly just matching buyers and sellers rather than making big bets with their own money.

How did Citigroup manage such a large gain? It's highly unlikely that it stemmed from the bank making big risky bets on the direction of interest rates. That type of activity was largely banned under the Volcker Rule, and frankly compliance officers these days would probably turn apoplectic if a trader went wild with some huge wagers.

Swap and Shop
Monthly volume on interest-rate swaps peaked in September
Source: CME Group

Instead, the Citigroup traders attracted a significant chunk of interest-rate swap trading business when there was finally more volatility and bigger volumes. Traders have been responding to Britain’s June vote to exit the European Union and a record sales pace for corporate bonds. September was a particularly active month, helping Citigroup beat earnings estimates for the third quarter with a 35 percent jump in bond-trading revenue.

Big Bond Year
U.S. investment-grade corporate bond issuance is usually less than $1 trillion at this point of the year, making 2016 the biggest volume year on record
Source: Bloomberg
Note: Data are for Jan. 1 to Oct. 27 each year.

Many asset managers opt to hedge out interest-rate risk when they buy corporate bonds, aiming instead to simply capture the extra yield paid out over benchmark rates.

Meanwhile, Citigroup has managed to raise its profile in debt markets in recent years. According to Greenwich Associates data, Citigroup was tied with Goldman Sachs in overall share of U.S. fixed-income business in 2016 after coming in third last year.

Citigroup's view of its success is simple. "Over the last several years we have been investing in our North American Rates business to better serve our customers, and we are now seeing positive results," the bank said in a statement. 

For some market participants, however, the explanation isn't so simple. In fact, they contend Citigroup and other big banks have colluded to keep competing interest-rate trading platforms out of the market. This is a nearly $400 trillion market, so any little inefficiency can mean huge profits to intermediaries in the trade. 

A class-action lawsuit filed in November last year said that 10 large banks "jointly threatened, boycotted, coerced and otherwise eliminated any entity or practice that had the potential to bring exchange trading to investors in the interest-rate swaps market," according to law firm Cohen Milstein Sellers & Toll, which represents the lead plaintiff, the Chicago Public School Teachers’ Pension and Retirement Fund.

By doing so, the suit argues, big banks prevented the market from becoming more efficient and less expensive for the many different investors who wish to exchange fixed interest-rate payments for floating-rate benchmarks or vice versa. (Citigroup had no direct comment on the suit.)

While the suit pertains to activities stemming back to 2007, it also focuses attention on how the market operates today. There's little for a middleman to do with interest-rate swaps, so volume equals revenue. But that also means it shouldn't be too difficult to innovate and reduce costs. 

New entrants are trying to muscle into this business. Citadel Securities, for example, has made some significant inroads in trading interest-rate swaps. Others, including Hudson River Trading and Virtu Financial, are also trying to break in.

Big banks shouldn't be standing in the way, if indeed they are. The less efficient markets are, the more money that comes out of the pockets of pensioners, retirees and insurance companies and into the coffers of big banks. While financial institutions are essential to modern capitalism and need to make money to survive, they shouldn't obstruct the creation of new, cheaper ways of doing things.

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

To contact the authors of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net
Rani Molla in New York at rmolla2@bloomberg.net

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