Swap Trading Changed

Terry Flanagan

JP Morgan’s fixed income inventory secretly gathers ammo from swap trading, and rightly so when the derivatives become a popular hedge.

With $2.2 trillion in operations spread throughout 60 countries, and an array of business lines, JPMorgan has come on top of the global broker-dealer platform with a 17% market share in fixed-income trading—a “Wall Street record”, according to the firm’s investment bank chief executive, Jes Staley.

Interest rate swaps (IRS) and credit securities are contributing to the bank’s largest stream of fixed income revenue, generating $350 million, and $375 million respectively. Both asset classes surpass revenue generated by cash equities, which was only $325 million in 2011. Asset-backed securities came in last place, generating $325 million. JPMorgan’s entire trading revenue earned the bank approximately $20 billion, which beats large multinationals such as U.S. Steel Corporation, according to Bloomberg data.

JPMorgan ultimately hopes to produce a total net income of $24 billion sometime this year in trading revenue, compared with last year’s figure, noted Doug Braunstein, chief financial officer Doug Braunstein.

Large multi-nationals have been a traditional long-time benefactor for sell-side trading desks as OTC (over the counter) and exchange-traded swap options are used for hedging purposes. Only less than 1% of fixed income trades were greater than $500,000 in transaction value, those large transactions were approximately 25% of total trading revenue, according to firm data.

Pensions also have become strong proponent of liability driven investing, or utilizing risk management tools, to keep their heads above water when it comes to their funded statuses. “Liability driven investing often need to manage a portfolio against known or contingent liabilities,” said Dave Wilson, managing director at Cutwater Asset Management.

JPMorgan has about 16,000 clients in its markets business, according to a presentation made by the firm. In 2011, asset managers comprise the largest percent of clients at 30%, hedge funds were 23%, and other banks were 16% percent. The firm’s client base is also global, with the majority of trading volume in North America, followed by Europe, Middle East, Africa and Asia.

However, threats loom ahead as regulatory changes such as the Volcker Rule may squeeze the life from fixed income securities that rely on their liquidity pools. Across the pond, European asset managers, such as U.K.-based Evercore Pan-Asset has shunned the use of exit swap-based ETF (exchange traded funds) because investors have questioned their stability and lifeline with heightened global regulatory scrutiny, citing that the Bank of England and the FSA (Fidelity Stability Authority) quoted particular swap products on their roster were “risky.”

Still, despite pending regulations, a rise in fixed income trading volumes, as shown by this recent JPMorgan upside surprise, has approached market participant radars.

“As the volumes continue to increase on these new pools of liquidity in fixed income, for more and more firms the instinct to sit on the sidelines waiting for regulatory clarity is being replaced by a desire to capture trading opportunities in these markets,” said Eiman Abdelmoneim, principal and director of product trategy at Sky Road, a provider of cloud-based technology solutions, such as Swap Trader 2.0.

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