Trading Titan Don Wilson Has Advice for Yellen on Market Fixes
(Bloomberg) -- As Janet Yellen takes over the Treasury and mulls whether to overhaul rules governing financial markets, one of the world’s biggest traders wants her to know that doing so could make it harder for his firm to step up during times of crisis -- as he says it did last year.
Don Wilson’s Chicago-based DRW, which emerged from the city’s trading pits three decades ago, counts among the largest players in key derivatives markets like interest rates and equities. Because of its ultra-fast communications infrastructure, some lump it in -- unfairly, Wilson says -- with high-frequency traders, firms whose automated systems can flit in and out of positions in tiny fractions of a second. The knock against these companies has long been that their liquidity purportedly doesn’t stick around when things get hairy.
But DRW did more than just stick around last year when U.S. debt trading locked up and other markets convulsed, Wilson says. The firm traded more, acting as a buffer in one of the wildest periods in the history of financial markets. Take Treasury futures, for example. DRW’s market share in March and April was 60% higher than what it had been during the previous 12 months, data from the company show. For futures linked to the S&P 500, DRW says it almost doubled its market share in March.
“Here’s a period of greatly heightened volatility. What happens to our market share? It actually goes up,” Wilson said in a Zoom interview from his home. “It’s the complete opposite of this narrative that’s floating around.”
A financial executive lobbying against fresh regulation is hardly surprising. However, his views carry more weight than ever given how DRW and firms like it have transformed markets around the globe. Banks no longer dominate trading like they used to, displaced by newer, less-regulated and often incredibly fleet-footed firms like DRW.
The question is whether these new market makers have made trading more unstable, and whether their price quotes are firm enough in moments of turmoil. The chaos in March revived the debate.
When she ran the Federal Reserve, Yellen was among experts concerned that banks’ diminished role could pose a problem during times of turmoil. Speaking in August 2017, she noted that “algorithmic traders and institutional investors” were playing a larger role in trading. “The willingness of these institutions to support liquidity in stressful conditions is uncertain,” she said.
Wilson says DRW passed that test last year. Not that he was just being charitable by ramping up trading during the chaos -- there were big profits to be made.
The 53-year-old founded DRW in 1992, and has since grown the company to include more than 1,100 employees working in cities including London and Austin, Texas. The firm’s reach now goes beyond trading to include real estate and venture capital. It’s also a force in cryptocurrencies, among the first conventional trading firms to enter that asset class.
The Treasuries market was especially stricken in March during the virus panic, with trillions of dollars of debt unable to trade because liquidity almost disappeared. That’s left overseers of this market, one of the world’s most important given its role in setting a variety of interest rates, wondering whether fixes are needed.
Top officials at the Fed, including Chairman Jerome Powell, have in recent months gotten vocal about the topic -- partly to prevent the central bank from having to bail out the Treasury market again -- with some suggesting the possibility of getting more trades backstopped by a central clearinghouse.
“I’m a little skeptical mandating central clearing for everything is going to be the solution that some people think it is,” Wilson said.
Partly out of self-interest but also in the spirit of ensuring a healthy marketplace, Wilson advises caution in designing any new regulations. Well-intentioned revisions -- that, say, boost capital requirements -- could end up increasing the cost of trading, reducing liquidity and potentially worsening the types of crises that regulators want to avoid, he said.
“It would actually squeeze liquidity out of the market and discourage people from providing liquidity in the market during these volatile periods,” he said.
Though Wilson doesn’t know for sure whether his peers stepped up, too, “our market share in those products increased dramatically during this period of heightened volatility,” he said. “We also allocated a lot more risk capital to those markets because we saw very compelling opportunities because there were major dislocations.”
Analysis by Greenwich Associates suggests DRW may have been an outlier.
“Volatility was so extreme early in March that even some of the largest nonbank liquidity providers stopped streaming prices to their bank customers, while traditional futures cash arbitrage strategies ceased to be profitable, further straining overall liquidity,” Kevin McPartland, head of research for market structure and technology at the firm, wrote in a report analyzing that period.
DRW saw plenty of trading opportunities because it deemed many derivatives contracts to be untethered from their real worth. Besides boosting its Treasuries and S&P trading, DRW lifted its market share in crude-oil futures by 51% and eurodollar futures by 29% in March versus the preceding 12 months, the firm’s data show.
“We are in the business of providing liquidity, but we’re motivated to do that because we see positive expected value in providing that liquidity,” Wilson said. When markets went haywire, “we saw greater positive expected value in providing liquidity and putting on positions.”
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