​​​​​​​Credit derivatives house of the year: JP Morgan

Risk Awards 2024: A team reboot has positioned the bank optimally across all credit products – and allowed it to meet the alleged threat of private lenders

The US team, left to right: Jake Pollack, Rui Fernandes, Howard Rothberg and Nick Adragna

It’s not news that JP Morgan is a credit industry leader – one of the first, largest and most innovative credit derivatives houses, it has topped many rankings since the product’s inception. What is perhaps more surprising is that it did so while beleaguered by outdated and unpolished operations.

By its own lofty standards – aspiring to operate at the leading edge of new technologies – some of last year’s credit offerings might as well have been propped up by fax machines and floppy disks.

But over the past year, JP Morgan’s credit team has been refreshed, retooled and relaunched.

The effort is already showing results, as the bank adapts to challenging liquidity conditions and the alleged threat of private lenders, and continues to hoover up market share in cash and derivatives markets.

The bank’s market share in large investment grade credit ETF trades [exchange-traded funds] has more than quadrupled this year. And its share in index credit default swaps has also increased materially, supporting a strong single-name offering – it had easily one of the biggest market shares in CDS on Credit Suisse – the year’s single largest credit event.

The upgrades stem from a now-merged equities and credit business that saw traditionally high-touch credit operations adopt successful technologies from the equities franchise.

We repositioned our business for a surge in credit situations and to be tightly co-ordinated across markets and time zones to capture a very large opportunity set in credit

Sanjay Jhamna

“The degree to which we [can] access liquidity across singles, programmes, primary and secondary ETFs was less developed a year and a half ago, and it now operates seamlessly,” says Jason Sippel, global head of equities, credit, public finance, and credit portfolio lending. “The outputs that we have on that are also materially better than we had historically.”

The firm’s pension risk transfer (PRT) size and capability have increased dramatically off the back of improvements in its portfolio trading capabilities, where hundreds of bonds are bought and sold in a single package. And, at the other end of the scale, it has made a big push in the private credit space, where this year it executed a $476 million collateralised loan obligation (CLO) for Ares Ivy Hill.

The bank’s transition may appear straightforward, but it would be far from easy for an institution without existing technology investments, a sizeable balance sheet and diverse client relationships on which to build.

But starting its push from an advantageous position didn’t eliminate the work required to make it successful.

$476 million

Collateralised loan obligation JP Morgan executed this year for Ares Ivy Hill

“You need a competitive offering that plugs into an existing architecture,” says Sippel. “It’s not so much repair, it’s a fine-tuning. Once you have strong market-making capabilities and analytic technologies, you can automatically decompose, deconstruct, have the right price for everything, have auto-collapsing into other liquidity channels that you have internally.”

Reorganising the derivatives team was intended to focus its offerings and more easily trade with clients.

“We repositioned our business for a surge in credit situations and to be tightly co-ordinated across markets and time zones to capture a very large opportunity set in credit,” says Sanjay Jhamna, global head of credit trading.

“Having the right organisation is about concentrating liquidity and information in one place to be able to redistribute that to clients,” he says. “That’s even more true of single-name situations that are rapidly evolving and where liquidity can be challenging.”

The reorganisation has paid off across the credit business. With index CDS spreads subdued, the year’s activity was more defined by single-name situations, as the team predicted. The desk led the way in the year’s most active situations, with sizeable market shares in swaps referencing Casino and Altice as well as Credit Suisse.

The UK team, left to right: Saul Doctor, Juan Reig Mascarell, Denis Gardrat, Andrew Crook and Chi Nzelu

In the latter, where concerns over the bank’s creditworthiness spurred trading activity – and the eventual UBS takeover and AT1 wipeout triggered questions about swap payouts – the bank held a market share of 35% in March single-name trading. It continued to be active in the following months, sitting behind a third of all notional traded in the year through July.

Index trading showed similar strength. The bank’s share of trading on Bloomberg and Tradeweb grew from 15.1% in 2022 to 18.3% in the first half of this year. The figure was also up from two years ago where 2021 equivalent index volumes gave the desk a 16.3% share.

Clients across the board – even funds that only trade periodically – give the bank strong reviews.

“JP Morgan is probably my first call when it comes to CDS,” says one buy-side credit trader. “I do a few of these trades a year, but I do them in size and they really can help you when you need it. I don't feel that I get treated differently because I’m not a [more active manager].”

The flexible organisational thinking extends to the cash side, as the bank responded to the interest rate-fuelled US regional bank crisis by quickly focusing sales and trading efforts onto clients that typically trade debt of distressed companies.

“We were one of the first to move regionals to the distressed desk,” says Nick Adragna, co-head of global macro and investment grade trading. “We knew the traditional IG customers would not be stepping in as buyers at that point, so we thought that would be the best way to find a new set of buyers. By doing that, we received a lot of two-way liquidity, and it helped jump-start a lot of the trading.”

Trading up

Some pieces of the credit business remain highly manual. Where the variety of corporate bonds and limited liquidity in cash bonds and single-name credit default swaps makes adopting equity-style central limit order books, large ticket execution, and algorithmic trading challenging. But other segments have become increasingly electronic in recent years, including smaller cash bond trades and flows associated with fixed income ETFs.

The process has introduced new challengers to traditional credit traders as electronic market-makers like Flow Traders and Jane Street dominate certain markets, forcing banks to update their technology for a faster-paced credit world or leave those segments of the business behind.

We organised ourselves with a fixed income ETF pod, which is tightly coordinated with our portfolio trading and our algorithmic trading

Sanjay Jhamna

This is the challenge JP has looked to embrace with its reworked credit operations to be more competitive in fixed income ETFs and the automated pricing needed to respond quickly and effectively to client requests.

Jhamna says it was important for the desk to be active in as many liquidity channels as possible to make markets for clients effectively.

“We organised ourselves with a fixed income ETF pod, which is tightly co-ordinated with our portfolio trading and our algorithmic trading,” he says.

The results have been dramatic when it comes to trades larger than $200,000 in North American investment-grade and high-yield credit ETFs. The bank started the year with an estimated market share below 4% in both rating segments, but their standing steadily rose by the summer, to over 18% for investment grade and over 14% for high yield.

Cost opportunity

Rising interest rates have created a longer-term opportunity for the credit team as higher rates have boosted the funding position for defined benefit pension schemes, meaning their assets match or exceed their liabilities. The situation has propelled the market for PRTs, where defined benefit schemes look to offload assets and liabilities to others, like insurance companies.

With PRTs, entire pension portfolios – largely made up of corporate bonds – are turned over to insurers, who will often want to make changes to the portfolio. JP Morgan is able to deploy its large scale and tech sophistication to execute these large portfolio transactions.

In the first half of 2023, PRT outpaced record 2022 volumes in the US, with over $20 billion of premiums written, while in the UK, over 40% of defined benefit schemes are said to be targeting a buyout.

With this in mind, and in view of the September 2022 liability-driven investment crisis in the UK – which saw a wave of capital calls and forced selling after a sharp rise in gilt yields exposed leverage in the pension industry – JP took a closer look at its offering.

Olivier Cajfinger (left) and Pierre Morrel

“We concluded that the new yield environment – and the fact that all these pension funds are better funded – will have a significant impact on the needs of investors involved in PRT, and we should collectively think about making sure we can be at the centre of those discussions,” says Olivier Cajfinger, global head of both IG sales and alternative credit sales. The latter team is a hybrid formed to serve more bespoke client needs that don’t fit easily in the typical investment-grade and high-yield segments.

“We’ve been agile enough these last 18 months to certify that the solution agenda would be complementary to our existing and stronger capabilities in flow,” he says.

Clients have taken note. A credit trader at an insurance company says that while several dealers have made a push into the PRT market, JP Morgan’s offering stands out.

“JP was the first one we worked with, and probably the one we've done the most with. We lean on their ability to source risk and on what they already have in their inventory. The fact that they have such a large balance sheet saves us a lot in transaction costs,” says the trader.

Portfolio trading is a critical building block for a successful PRT business, but it’s not the only one

Rui Fernandes

The focused offering has meant improving capabilities in products like portfolio trades, and helping clients optimise targeted pension portfolios to match their own duration, credit quality and yield requirements.

“Portfolio trading is a critical building block for a successful PRT business, but it’s not the only one. As a team over the last 12 to 18 months, we have tried to integrate all of these different building blocks – portfolio trading, TRS [total return swaps], repack, illiquids – into a consolidated offering that we can present to clients,” says Rui Fernandes, global head of equities and credit structuring.

When it comes to portfolio trades, the PRT transactions can be sizeable and take time to finalise before execution, like the $4 billion bi-directional trade on which the team worked with a client for months to optimise then execute the transaction.

Nonetheless, he says the amount of flow portfolio trade the desk sees still outweighs its PRT transactions. In markets for both high-yield North American bonds and investment-grade bonds from EMEA issuers, JP more than doubled its 2022 average quarterly market share in portfolio trades to around a 12% quarterly average in the first half of this year.

“We had a $5 billion bi-directional trade in August brought in through our traditional relationships,” says Adragna. “You needed to know the depth of liquidity and have credit expertise, and we were able to unwind more than 25% of it throughout our ecosystem.”

Private credit threat?

The credit team has taken heed of the growing private credit market that some see as a threat to traditional financing businesses. With $1.5 trillion allocated and deployed in private credit, the market rivals segments of traditional high yield and loan markets.

JP rejects the common narrative that characterises the buy side as the interloper siphoning bank lending profits by providing funding directly to corporates and private equity sponsors. Banks, after all, have been lending to companies for years in the syndicated loan market, and it believes it can still play a role in direct lending relationships.

Jake Pollack, global head of credit financing, direct lending and CLOs, sees the market as another opportunity for the bank.

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“I don't think it’s right to say the banks are losing on private credit. We view private credit as the same borrowers with a different delivery mechanism. We’ve always gone direct to corporates, and we’re still doing it, but we’re doing it in this private credit market,” he says.

The bank has steadily increased that bet in recent years – in 2023, it has made tens of billions of dollars in commitments to private credit, over four times its 2017 allocations. The business expanded to include collateralised obligations backed by private credit loans, structures that see issuers bundle together loans and sell tranches of the debt to investors based on risk.

The bank can then finance direct lenders, who in turn lend to companies, or help firms structure and sell CLOs, as it did with Ares Ivy Hill, helping the manager securitise its existing revolving credit facility for $476 million. And while JP backstopped the facility, attracting over two dozen investors meant it didn’t need to fulfil the commitment.