Flow market-maker of the year: Deutsche Bank

Risk Awards 2023: German bank takes FX tech cross-asset as part of new flow-focused strategy

Deutsche Bank/Flickr

In May 1966, Bob Dylan was booed at a concert at the Free Trade Hall in Manchester, England. His crime? Dylan had gone electric. To the shout of “Judas” from one outraged fan, the singer obstinately made his way through his set, ignoring the cries from a crowd appalled by the folk icon’s embrace of modern rock ’n’ roll.

Deutsche Bank’s co-head of investment banking, Ram Nayak, is an unlikely Dylan. But like the sixties superstar, he has also departed from his own roots structuring complex derivatives deals and switched the focus of the trading business to high-frequency, electronic fixed income and currencies (FIC) flow trading. In other words, the flow monster is back.

On an annual basis, sales and trading revenues have risen from $5.25 billion in 2019 to what analysts expect to be $9 billion for the full year of 2022. Deutsche thrived making markets in European government bonds, spot foreign exchange and FX swaps and forwards in 2022. In the third quarter of 2022, sales and trading revenues leapt 38% compared to a year earlier to hit $2.2 billion, as volatility soared last year.

Nayak says the “vast majority” of that growth stems from the expansion of Deutsche’s flow trading business in FIC. He is adamant the climb in revenues is the result of a long-planned strategy bearing fruit, rather than simply market timing after a year of extreme volatility in rates and FX.

“We’ve outperformed our peers for each of the last nine quarters,” says Nayak, citing data from public sources.

Ram Nayak, Deutsche Bank

Moving away from a capital-intensive solutions business to a flow trading operation has been a long road. The switch has its roots in Deutsche’s response to its 2016 crisis, when the bank was weighed down by litigation and regulatory probes, and under pressure to scale down its derivatives book.

Regulatory changes also pushed the bank towards a flow trading model. Nayak says Capital Requirements Directive IV – the European implementation of the post-2008 Basel III capital rules – forced the trading business to rethink the way it was deploying its resources.

“You needed to effectively change the way your business operated,” he says.

The transformation to concentrate on flow required significant investment in the bank’s technology, with a focus on taking capabilities from its strong FX franchise across to fixed income. But fast forward to 2022, and Deutsche finally had a new system in place just in time for volatility to return to markets as central bank policy and geopolitical turmoil came to the fore.

Going with the flow

Roel Oomen, a Dutch econometrics lecturer turned FX trader, has been at the heart of Deutsche’s transformation into a flow trading machine. Oomen, the bank’s head of FIC quant trading since 2018, says the core of the bank has been able to repurpose the technology and trading methodologies developed for spot FX business into its rates, FX forwards and precious metals franchise.

Bolstered by sticky business from corporate and institutional clients, spot FX trading has long been a cornerstone of Deutsche’s trading franchise. Automating the hedging needs of corporate clients has become a key plank of its FX spot strategy, while hedge funds and institutional FX clients have been drawn to the bank’s segregated execution desk, which sits separately from its principal business and handles fixing orders and offers client execution algos.

Deutsche has always been a prominent liquidity provider in spot FX. I’ve always had them as a sophisticated market-maker, a step above the other LPs

New York-based trading platform executive

FX spot is also a business that is still growing at the German bank. Despite FX spot being one of the most competitive asset classes to trade, Deutsche’s FX spot volumes as a proportion of total trades settled through settlement utility CLS doubled in the two years to July.

“Deutsche has always been a prominent liquidity provider in spot FX,” says a New York-based trading platform executive, who praises the way the dealer has consistently provided liquidity to his platform.

“I’ve always had them as a sophisticated market-maker, a step above the other LPs,” he notes.

The platform executive says Deutsche’s “robust data set” helps the German bank make “better liquidity decisions” than its rivals.

Part of the growth Oomen puts down to its laser focus on minimising leakage of client order information, particularly by matching off client orders internally to avoid going to public venues where information leakage can move prices against them.

Roel Oomen, Deutsche Bank

The bank has also been moving forward with client execution algo development, launching Stark in February 2022, which trades against a liquidity pool consisting of Deutsche’s principal desk, other banks and non-bank market-makers.

“We’re now getting pretty solid evidence that this is the best-performing algo on the street by tracking error and other metrics,” says Oomen.

The bank also pushed ahead with an entirely new way of executing client orders. Typically, if a client wanted to minimise its information leakage it would trade bilaterally with a liquidity provider, but that was only done at a so-called risk-transfer price that involves crossing the bid/offer spread.

If a client wanted to earn that bid/offer spread, it could leave passive orders on trading venues, but that order information can create market impact and move prices against them.

To bridge the gap, in early 2021 Deutsche launched principal resting orders (Pro), an execution methodology that allows clients to leave passive orders bilaterally with the bank for it to work against its internal liquidity, allowing it to earn some of the bid/offer spread while reducing information leakage.

“The configuration of the Pro order enables the client to control the trade-off between crossing spread for immediacy of execution versus saving on – or even earning – spread, while accepting a degree of execution risk,” says Oomen.

Pro took off in 2021 and through 2022, and a tenth of the bank’s principal spot trading volumes are now executed using this approach, a figure Deutsche wants to double by the second half of 2023. The bank is also looking to expand the order type to FX swaps.

FX focus

FX swaps have also been a big focus of Deutsche’s flow push, particularly in the interdealer market. The bank’s market share more than doubled between January 2019 and May 2022. And during 2022, it was consistently ranked top on Deutsche Börse Group’s 360T platform for forwards and FX swaps.

Oomen says a key driver has been its market-making role on CME’s FX Link platform, which allows users to trade the spread between FX spot and futures via a central limit order book. The exchange touts the service’s ability to replicate FX swaps, and Deutsche has been using it as an alternative liquidity pool to hedge flow on its electronic swaps desk.

Related

Deutsche Bank plans expansion of Pro algo to FX swaps

German bank’s principal resting order algorithm should support swap clients in 2023

The bank hasn’t ignored the client side either – a portfolio manager at one hedge fund says Deutsche’s spreads for FX forwards and swaps are “super competitive”, and that he was “more than happy” with the bank’s offering.

He says the fact his trades with the bank have “no real market impact” allows him to “scale in and out of market positions”.

Deutsche has also looked to boost its emerging markets swaps and forwards offering by bringing it onto the same technology stack as its G10 currencies. The bank says this allows it to provide more efficient pricing and better analytics that can help with “client liquidity optimisation”.

Electronic advocates

The big strides Deutsche has made in FX have also been carried over to rates to help bolster the business’s flow capabilities.

For European government bonds, the bank took on a new pricing model this year that was adapted from the FX side. Deutsche’s bond traders say the system aggregates public data with information from the bank’s own inventory to map out a proprietary view of pricing at every moment. It also allows the bank to process granular and fast-moving market data at millisecond horizons, along with risk views that can span hours or days.

“We’ve become more systematic and data oriented in the last 12 months,” says Kemal Askar, Deutsche’s global head of rates.

“That means we can provide a more consistent and competitive electronic offering to clients, which has also consolidated our position during periods of heightened volatility in the rates markets.”

We’ve become more systematic and data oriented in the last 12 months

Kemal Askar, Deutsche Bank

Another driver of the rates boost was a restructuring of the rates sales force. In European rates, the bank did away with the split between a voice sales desk and an e-sales team, and instead trained its voice sales force on the electronic side of the business.

The bank found that the new structure more effectively mirrored the way buy-side clients structure their own trading teams, with a hedge fund trader executing electronically likely to be the same individual picking up the phone to transact larger tickets. The newly structured rates sales team polled more than 100 clients about the state of the European bond markets, which found an unequivocal link between the quality of the bank’s electronic execution offering and customers’ willingness to engage in more sophisticated trading strategies over the phone.

As a result, Deutsche has looked to change the mindset of its sales team away from hunting down what are known as “big elephant” trades, to becoming advocates for electronic rates trading, regardless of ticket size.

“This has been a cultural shift for our salespeople and trading in ensuring that the e-platform is delivering and clients are serviced just as well on the smaller tickets as they are the largest,” says Panayiotis Stergiou, global head of the institutional client group and co-head of FIC structuring at Deutsche Bank.