The Italian national flag, center, flies on top of the Quirinale Palace in Rome, Italy.(Photographer: Alessia Pierdomenico/Bloomberg)

Citadel Securities Has Swaps-Trading Bonanza in Italy Chaos

(Bloomberg) -- The kind of tumult that enveloped markets during last month’s Italian political meltdown isn’t something Citadel Securities LLC’s Paul Hamill would wish upon his clients. Yet, it was the perfect opportunity for the firm to showcase its bona fides as an interest-rate swaps dealer.

As political turmoil sent Italian bond yields surging the most since the advent of the euro, and investors fled for the safety of Treasuries and bunds, the scramble to trade interest-rate risk saw the market maker post its biggest day ever in swaps transactions. It also served as a proof-of-concept of sorts for the company, founded by Ken Griffin, amid a recent expansion into more niche structures.

“Those are the days that customers remember, who was there when they needed to trade,” Hamill, Citadel Securities’s global head of fixed income, currencies and commodities, said in an interview at the firm’s New York office. “We built this business over the last couple years during a very low volatility environment, which has sometimes made it harder for us to demonstrate our edge. But days like that -- though you wouldn’t wish for them everyday -- do help us stand out.”

Citadel Securities Has Swaps-Trading Bonanza in Italy Chaos

As Italy’s problems began to unfold last month, trading in interest-rate swaps gathered pace. Citadel facilitated about $25 billion in notional value of swaps traded in a single day on May 24, its biggest trading day since the company began making markets in the derivatives in 2014, and over four times its previous peak. Trading remained active days later as Italian two-year bonds went on to plunge the most since the euro came into existence and yields on 10-year bonds surged to four-year highs.

Italy is back on investors’ radar Thursday, as two prominent euroskeptics were handed key roles in the country’s parliament. Italian bonds and stocks slumped on the news, which came as Interior Minister Matteo Salvini threatened to stir up trouble for the European Union over migrants.

Flattener Trade

Hamill also attributes the spike in the firm’s business to a new array of custom swap offerings being rolled out to the company’s clients, which include asset managers, hedge funds, banks and pension managers. Citadel Securities last year hired Daniel Gottlander away from Citigroup Inc. to lead the charge in delivering more bespoke products. His team has introduced the new, non-vanilla swaps to about 110 of the firm’s customers. Citadel Securities plans to make them available to all of its roughly 1,000 institutional clients in a few weeks.

Citadel Securities Has Swaps-Trading Bonanza in Italy Chaos

“We developed tools to move further into the swaps space to add the full spectrum of offerings,” Gottlander said in the interview at the firm’s 350 Park Avenue office. “Everything we have said to clients about what we can offer to them with these custom swaps came together that day.”

One recent large custom trade was a forward swap wager set to profit if the Treasury curve continues to flatten. U.S. rates traders, as well as Federal Reserve officials, are keenly focused on the risk of a possible yield curve inversion as the gap between some maturities has reached the narrowest since 2007.

The benchmark 10-year Treasury yield’s swings around 3 percent also induced more trading in government debt and swaps, according to Gottlander, who was part of the Citigroup swaps desk that brought in more than $300 million of revenue in 2016. The yield, now at 2.897 percent, reached as high as 3.13 percent on May 18 before retreating as the Italian turmoil spurred a move to safety.

“When the 10-year yield broke above 3 percent, we saw a lot of client interest to take the other side of that trade,” Gottlander said. “The volatility overall emphasizes the role of market-makers and dealers in the marketplace.”

Primary Dealer

The next big push in swaps for Citadel Securities will include adding more euro-denominated structures, non-standard floating-rate deals and eventually cross-currency basis trades. In addition to interest-rate swaps, the firm now trades credit-default swap indexes, on-the-run and off-the-run Treasuries, and currencies.

Europe’s phased requirements for broker dealers to centrally clear swap trades are likely to provide a boost to Citadel’s push into the region. The firm became a fixed-income systematic internalizer as Europe’s MiFID II came into effect, enabling it to trade with counterparties using its own capital away from an exchange or other trading venues.

Even with the current focus on swaps, Citadel Securities still expects to eventually become a primary dealer, one of the 23 firms that currently trade with the Fed directly and are obligated to bid at U.S. debt auctions. Hamill believes the company can earn the designation by 2020, and in preparation it plans to add dealings in bills, Treasury Inflation Protected Securities, known as TIPS, and Strips (notes and bonds split into principal- and interest-only securities) over the next 15 months.

“Becoming a primary dealer is not a means to an end for us,” Hamill said. “But it will be a natural thing for us to do once we have the entire suite of Treasury products. We’d be very proud to call ourselves a primary dealer, there is no question about it.”

©2018 Bloomberg L.P.