Buy-side firms can create better opportunities for generating returns and hedging risk if they are able to engage in derivatives markets effectively.
In this interview we look at the groundwork needed for an investment manager to trade derivatives, from the agreements with counterparties to minimise friction, the access to listed and OTC markets, and the trading capabilities.
Discussing best practice in this space are James Wallin of AllianceBernstein, Phil Lloyd of NatWest Markets and Lee Bartholomew of Eurex, speaking with Ruth Emery of Trader TV.
Ruth Emery: Welcome to Trader TV – your insight into trading for professional investors. I’m Ruth Emery. Derivatives can optimize returns and lower costs for investors. However, the investment managers need access to these instruments efficiently to realize those benefits. Lee Bartholomew of Eurex, Phil Lloyd of NatWest Markets and James Wallin of AllianceBernstein are here to discuss how buy-side firms can do just that.
What is an asset manager looking for from its derivatives trading operation?
James Wallin, Senior Vice President, AllianceBernstein: Fluidity, the ability to, you know, enhance up in nuanced way, and to be ready to trade across the spectrum of agreed upon instruments. We have numerous accounts that need to be up and running, both with a clearing broker and a full suite of executing brokers. So our job in terms of the middle of this solution for derivatives trading is to make sure that our accounts are all papered.
Phil Lloyd, Head of Market Structure & Regulatory Customer Engagement, NatWest Markets: I have a role to ensure that my customers on the buy-side are fully papered and documented, and that includes all funds, so they can trade on block. And ensuring that I have the responsability for the terms, because while my legal docs team have a view, I need to take ownership of risk appetite for what is within the envelope and to ensure that our relationship with our customers is more of a partnership.
Ruth Emery: So Lee, how will the end investor see the benefits of efficient derivatives trading?
Lee Batholomew, Head of Ficed Income ETD Product Design, Eurex: Having an efficient trading setup allows the trading desk as well as the portfolio managers to focus on Alpha, especially in fixed income. That’s becoming more challenging with the growth of passive and so forth, so you definitely want more focus on your execution. I think it is allowed and certainly through 2020 you’ve seen an acceleration of technology. By having the operational side comfortable and you’ve got that seamless kind of transition, it makes engaging, whether it’s at our level or on the sell-side, a lot easier because you’re focusing more then on the kind of ways to make the market safer, more robust, but also, I would say, more liquid.
Phil Lloyd, Head of Market Structure & Regulatory Customer Engagement, NatWest Markets: The efficient outcome would be that our customers are able to access our liquidity in an efficient manner, allowing them to serve their end users. And obviously, they have an obligation with their end users to ensuring the best outcome, which is a function of many factors, including best price speed and ability and confidence to handle large trade size, etc, etc. So if we do our job and they do their job, then their end customers will have the best outcome. And that comes down to reducing any friction, be it access to liquidity or documentation or not having any trade breaks fx.
James Wallin, Senior Vice President, AllianceBernstein: Phil mentioned that he’s responsible for, among other things, the overriding terms of the arrangement. And that’s important because, you know, you can gain alpha on the trade and give it up on the back end if you don’t get the terms right. And that’s important for the buy-side participants to understand and for their sell-side partners to agree to ahead of time.
Ruth Emery: And how are operational market and execution risks overcome by the effective operational setting up?
Lee Batholomew, Head of Ficed Income ETD Product Design, Eurex: As the buy-side becomes more electronic in their process and automated, that then frees them to focus on their cash side of things and offer, but then it also focuses on what we can do going forward and new innovations really.
James Wallin, Senior Vice President, AllianceBernstein: The greater stress that’s in the market, as we saw during the initial weeks of the pandemic, the more important the terms are of making sure you can keep your trades on and don’t end up with an event at default that you hadn’t even thought was possible. We did well during the pandemic because we’ve given a lot of thought to that and worked with our partners on the sell-side.
Phil Lloyd, Head of Market Structure & Regulatory Customer Engagement, NatWest Markets: When I speak to heads of trading on the buy-side, it’s incredible how much they have an understanding now of market structure reform. So what happens in the post MiFID II world, wholesale markets review, Europe coming out with their tweaks to MiFID II, you tinker with the edges of rules and you create a butterfly effect and that could impact liquidity, operating rhythms and risk appetite. And so the more that we are all communicating in a transparent way, the better the overall outcome. So that comes back to the front office, taking more ownership front to back. As you automate more, the relationship becomes a more important part of that ecosystem.
Ruth Emery: What are the risks of inefficient trading?
Lee Batholomew, Head of Ficed Income ETD Product Design, Eurex: in the pandemic the market accelerated through a lot of bottlenecks. And when you’re looking at margin and set up, especially for the buy-side, the easier you make it to access, whether that’s operationally risk or liquidity, it makes a big difference. And also from an exchange perspective, you know, you’re focused on margin because it’s becoming more and more important, right? And if you’re not focused on the operational side, then slippage on execution and liquidity becomes even more prevalent.
Phil Lloyd, Head of Market Structure & Regulatory Customer Engagement, NatWest Markets: Inefficiencies, I guess, will lead to bad outcomes for our customers, operational headaches being painful to do business with, which starts to erode years and years of building up a trusted partnership relationship. So if trades are breaking all over the shop and we’re not there when they need us, be it market stress or normal markets, that’s how I would interpret inefficiencies.
Ruth Emery: I’d like to thank James, Lee and Phil for their insights today, and of course, you for watching. To catch up on our other shows or to subscribe to our newsletter go straight to TRADERTV.NET.
