Citadel Securities is well on the way to replicating its US dollar interest rate swap success in the index credit default swap market, having become a top-three liquidity provider in the most heavily traded products just three months into operations.
The market-making arm of the Chicago-based hedge fund began trading CDX Investment Grade and High Yield on-the-run benchmarks in mid-April after luring CDS index trader Tian Zeng from Citigroup. By the end of June, the firm was top-three by notional value traded on the Bloomberg platform – the largest venue for index CDS trades – and now boasts market share of around 10% in CDX IG and 13% in CDX HY.
“Credit index is a natural product for us to make markets in: it is liquid and trades via standardised benchmarks in high volume,” said Paul Hamill, head of fixed income, currencies and commodities at Citadel Securities. “We’ve been able to leverage our client footprint from our US dollar swap platform, and although these markets in some respects are very different, we’ve seen considerable early success.”
But the firm is not complacent and is now eyeing European expansion. Following the hire of Sylvain Lebre, a credit index trader from Barclays, Citadel plans to begin trading iTraxx Main and Crossover indexes during the fourth quarter.
Using superior technology, and without the burden of legacy swaps books, the nimble trading firm has been able to offer live prices and tight bid/offer spreads, allowing it to encroach onto the turf of large dealers that dominated the swaps market for decades. Indicative of superior pricing, Citadel’s hit ratios on the Bloomberg platform already outpace all of its CDS competitors by a significant margin.
Call for liquidity
Citadel’s arrival in credit derivatives responds to calls for new liquidity providers. Unlike interest rate swaps, where many second and third-tier banks have trading capabilities, CDS is a scale product dominated by the top-tier houses that have the capacity to trade in large size. Many smaller players have departed in response to hefty capital charges on market making activities and reduced activity. Gross notional of multi-name instruments outstanding stood at just US$5trn at the end of 2015, down from US$25trn eight years previously.
“The fundamental requirement for a credit index business to be successful is earning access to customer flow and we are working hard on building our sustainable and growing client franchise, which started initially with our US dollar swap business,” said Hamill. “Index CDS is a client-driven business so you can’t play around the edges – it is essential to be in the flows.”
The firm has attracted more than 175 active clients on its CDS platform, including hedge funds, real money asset managers and banks.
“Growing from zero to 175 clients in three months and earning a top-three market share of over 10%, demonstrates that there’s strong demand for differentiated liquidity providers,” said Hamill.
Nowhere is that demand for liquidity greater than in the single-name CDS market, where even top-tier players have reduced activity or stepped away altogether. Citadel views single-name CDS as a significant opportunity due to the standardised nature of the product, but the lack of a clearing mandate remains a problem.
“Clearing is a cornerstone for new competitors like us and although some buyside firms are choosing to clear single-name CDS, it’s harder to make the case for investing in a business underpinned solely by voluntary clearing,” said Hamill.
While ICE Clear Credit offers clearing on around 450 single-name contracts, the SEC, which is responsible for security based swaps including single-name CDS, has yet to mandate the instruments for clearing.
