Interest rate derivatives house of the year: Barclays

Risk Awards 2024: Responses to BoE LDI intervention and yen vol shift underline business’s ‘bouncebackability’

Left to right, top: David Cross, Sebastian Fassam, Carl Scott, Sarah Kiveal, Tarun Mathur
Left to right, bottom: Hamza Hoummady, Yun Zhang, Jerome Bru

Photo: Joy Ekpeti

A number of firms have shown resilience amid the difficulties afflicting the financial markets over the past year, but Barclays is among the few to have thrived as a direct result of these challenges.

This ‘bouncebackability’ first became clear in its response to the crisis that followed the UK government’s ‘mini-budget’ in September 2022. Barclays was duration manager on a syndication of UK government bonds that had been due to take place when the Bank of England (BoE) intervened to prop up gilt prices. Although press reports suggested Barclays had lost millions following the intervention, its sterling desk in fact managed to chart a course through record levels of volatility and come out in the black on the same day.

As we went into the syndication, we knew it was going to be volatile

Carl Scott, Barclays

“As we went into the syndication, we knew it was going to be volatile,” says Carl Scott, head of Europe, Middle East and Africa rates trading at Barclays. “In the end, it turned out to be a good day both for our clients and the firm.”

This was part of a wider story in which the bank re-emerged as a top player in the rates market. It’s a story that takes in the US regional banking crisis, the surge in yen rates volatility as the Bank of Japan started to loosen its decade-long monetary policy, and Barclays’ emergence as one of the top dealers in European government bonds.

“They used to be really big in Europe, and now they’re on their way back,” says a source in one European bank’s treasury team. “They’re maybe the most important mover.”

The turnaround has been aided by increased investment in people, technology and the balance sheet.

Budget bedlam

Few in the UK’s finance sector will forget the turmoil that followed the mini-budget, and Barclays has a particular reason for having the day permanently etched on its collective memory.

There was nothing notable about the re-opening of the UK’s 2053 1.5% green gilt when it was first announced and, after a delay for the funeral of Queen Elizabeth II, syndication was set for September 28. Barclays was already a joint bookrunner on the syndication but the separate role of duration manager had yet to be decided. This is typically announced a week beforehand, which would have meant September 21 for this particular deal.

Taking on the role of duration manager for a gilt syndication requires a bank to hold large amounts of the issuance on its balance sheet in order to handle ‘switches’, where market participants swap out old versions of the bonds for freshly minted ones. This is relatively straightforward in normal market conditions, but it becomes trickier when volatility is high.

Volatility in sterling bond and currency markets was increasing through September as prime minister Liz Truss’s plans to simultaneously cut taxes and increase spending were becoming clear. Her government was due to formally set out its plans in the ‘mini-budget’ on September 23.

For us, the sterling rates complex in all of its variety is very much part of our heritage, and we felt that we wanted to play our role

Tarun Mathur, Barclays

Knowing the increased risks it could be facing, Barclays put its hand up to pitch for the duration manager role anyway.

“The question that we asked ourselves when we came to be duration manager was ‘if not us, then who?’,” says Tarun Mathur, co-head of European rates sales at Barclays. “For us, the sterling rates complex in all of its variety is very much part of our heritage, and we felt that we wanted to play our role.”

When the mini-budget was finally unveiled, everyone’s worst fears were realised. Yields on 30-year gilts surged by more than 100 basis points between September 22 and 27. This placed intense pressure on UK liability-driven investment funds using received-fix interest rate swaps and leveraged gilt repurchase agreements. Margin calls on the positions forced the LDI funds to dump gilts into the market to obtain cash. This pushed yields up even further, thus creating a doom loop.

One-year options on 30-year swaps went from around 115 vols in August to more than 200 on the day of the syndication, according to Bloomberg data.

Ahead of the syndication, Barclays gave its sterling desk bigger risk limits than usual because of its role as duration manager, and granted larger value-at-risk limits given the heightened volatility. It also had to rethink the typical duration manager strategy of going in with a big short-gilts position to hedge the expected switch orders.

We were very nimble with risk and focused on talking to clients, assessing their demand and facilitating trading

Sarah Kiveal, Barclays

Barclays’ role as a duration manager, and its status as the largest UK investment bank during a period of acute stress in the sterling market, meant it became the focal point for gilt flows on September 28.

With some LDI firms still needing to sell large clips of gilts and the futures market unable to handle large-scale hedging, the bank was, at its peak, running between £1 million and £2 million of DV01 exposure – the sensitivity to a 1bp move in underlying rates.

Trading flows were less unidirectional on the morning of September 28 than they had been over the previous days, as hedge funds had arrived to pick up cheap gilts. Barclays’ plan was therefore to not go in very short into the syndication, but to instead use the big flows that were being concentrated on the bank to take it out of the risk as it arose.

“We were very nimble with risk and focused on talking to clients, assessing their demand and facilitating trading,” says Sarah Kiveal, head of gilt trading at Barclays.

The strategy would ultimately be vindicated.

At 11am, the BoE unexpectedly announced it would be buying up longer-dated gilts to stabilise the market. “The noise on the [trading] floor erupted,” says Scott.

Yields on 30-year gilts fell by around 100bp almost immediately, which would have had a severe impact on the sterling desk had it held a conventional short position. However, Scott says Barclays had only a small short position at the time of the BoE’s intervention and therefore suffered only a “trivial” loss.

Moreover, in the following hours, as flows continued to concentrate on Barclays’ gilts desk, the traders made enough revenue to more than cover the small hit caused by the intervention. Barclays was able to manage the risk from the post-syndication flows thanks to the heightened domestic and international interest in sterling rates at the time.

Big in Japan

Another big rates story of the past year has centred on Japan, where the central bank has been weighing up ending its long-running government bond-buying programme, known as yield curve control.

YCC, which the Bank of Japan has pursued for more than a decade, had all but removed volatility in yen rates. Although it would have been tempting for Barclays to step back from the market during that time, the bank was active with dollar structured products that were being purchased by Japanese investors, and which gave it a regular supply of swaptions volatility to distribute.

It decided to retain a vol presence by merging its vanilla, exotic, dollar and yen vol teams. This enabled it to stay connected to Japanese and foreign clients in anticipation of a return of yen rates volatility.

“We have a very big exotic desk, so I thought it made sense to combine them and then keep this optionality live,” says Yun Zhang, head of Asia macro trading at Barclays. “And when the market comes back, we’re right there to serve our clients.”

Zhang Yun and Jerome Bru

Photo: Joy Ekpeti

The plan paid off when, just days before Christmas, the Bank of Japan made a surprise tweak to its YCC policy, causing vols on one-month options on 10-year yen swaps to nearly double overnight. They have remained elevated since, and have spiked around dates when the central bank has scheduled meetings.

With demand for yen vol surging, supply was an issue. But with longer-dated yen rates moving into positive territory, and the dollar/yen cross-currency basis going deeply negative, Barclays’ Japanese clients were turning their attention to yen structured products. Zhang says industry surveys put Barclays in the top three in the market for callable notes issued by banks and corporates – both as an issuer itself and as a provider of hedges for third-party issuers. This gave the bank a big supply of at-the-money yen swaptions that it could distribute to clients.

However, foreign hedge funds were more interested in payer spread structures, where they buy at-the-money and sell high strike swaptions, also known as skew. Although Barclays had a plentiful supply of at-the-money positions from structured notes, the skew was generally harder to distribute.

You have this very good dynamic in the book that makes us very comfortable trading the skew, even though there are some mismatches

Zhang Yun, Barclays

The bank nevertheless managed to find domestic insurers and bank treasuries willing to buy the skew as a tail hedge, thus allowing the risk to be mostly matched off. A senior trader at one Japanese life insurer says Barclays is a top-two player in the yen vol market, a position it puts down to the bank’s presence in structured products.

The only risk remaining was a maturity mismatch between hedge funds’ shorter-dated expiries and tails, and domestic investors’ longer-dated equivalents. This gave Barclays a negative exposure to changes in vega for movements in underlying rates, or ‘DvegaDrates’ – as, for example, a rise in rates would see the shorter expiries gain less vega than what the longer expiries lose, so net the desk loses vega.

Zhang says that as yen rates and vol have been positively correlated, Barclays positioned the book in such a way that it was positive DvegaDrates – so that when rates go up, the desk gets longer vol and vice versa. This was a good fit with the Bank of Japan’s policy, as rising rates would indicate the end of YCC and a big vol increase, and falling rates would indicate YCC was here to stay and that vol would fall.

“You have this very good dynamic in the book that makes us very comfortable trading the skew, even though there are some mismatches,” says Zhang.

Great at rates

Among Barclays’ clients there is a sense that the bank is re-emerging as a top rates player after years at the back of the pack.

A portfolio manager at a European asset manager and a senior trader at a large UK LDI manager agree that Barclays has been making a big push this year, and they expect it to be a top counterparty in the years to come.

A large US asset manager also believes Barclays has become more aggressive on pricing. He says it wants to win flows to help get it out of risk or to distribute to other clients, instead of tightly managing risk with a wide bid-ask spread as it has done in the past.

Michael Lublinsky, Barclays’ global head of macro, says that since 2018, the bank has focused on giving its rates team extra resources to allow it to act as a counterbalance for other business lines during periods of volatility. This has included an increased technology budget and a 25% rise in balance sheet allocation.

Michael Lublinsky, Barclays

Some of the changes the bank has made in the past year have been structural. It has moved away from having macro trading heads in the US and Europe, and instead looked to have rates, foreign exchange and emerging markets heads to give the desks greater responsibility and accountability.

It has also gone on a hiring spree, bringing in electronic trading expert Carl Scott from Citadel Securities to run rates trading in London, and Dan Orlando from Deutsche to do the same in the US. Guy Winkworth has also joined from Deutsche to run sterling and inflation trading, and Hamza Hoummady has returned after a spell at Goldman Sachs to run Europe, Middle East and Africa non-linear trading and a new strats team.

Lublinsky says the development of the strats team has been crucial to growth over the past 12 months. The team puts quants, technology experts and traders together on the same desk to help increase automation, and develops ad hoc or longer-term tools for traders to enable them to work faster or more efficiently.

“If those guys are sitting on different floors and communicating over email, the chances of success are low,” he says.

Quicker off the draw

The structural changes have had a particularly strong impact on the non-linear side of the business. Hoummady says Barclays has built a tool that can parse unstructured text data from the broker market and client enquiries. This gives traders more information, which enables them to respond to requests for quotes 10 times quicker than before, and at tighter prices.

“For example, a trade would come in, [and we] would be immediately able to say what the broker activity around this particular risk is, plot the various risk factors over time, and look at historical flows if you want to recycle it,” he says. “It’s a fully fledged ecosystem around enquiries.”

They can always be relied upon for a consistent price, even if they don’t have an axe or if it doesn’t fit the book

UK hedge fund portfolio manager

A US hedge fund portfolio manager says Barclays has “stepped up its game a lot” this year in vol. He adds that the bank is the best in the world for curve options and in the top two for swaptions, and praises its ability to either respond quickly to pricing requests or manage expectations when this is unlikely to be possible.

A UK hedge fund portfolio manager also praises the bank’s non-linear capabilities: “We do big size and that’s never an issue with them. Our premium spend can go over a million and it’s never a problem. They can always be relied upon for a consistent price, even if they don’t have an axe or if it doesn’t fit the book.”

The portfolio manager says the bank’s trade recommendations have improved significantly, and that it was the first to recommend options-based euro curve steepener trades at the start of 2023. The strats team came up with the idea for these trades, which are based on one-year expiries on the difference between 30- and 10-year euro interest rate swaps. The curve was inverted throughout 2022, but Hoummady says the vol premium on the structure was expensive at the end of the year.

However, in mid-January this year, a 60bp rally in bund markets signalled that the market for euro curve steepener trades was close to the end of the hiking cycle. Vol on the structures came down and 0% caps on the spread went below seven cents premium – the median for the past 10 years had been 25 cents – giving hedge funds an ideal entry point. Hoummady adds that Barclays ended trading north of €50 billion notional across a variety of structures tracking the theme.

Walk the line

The strats team has also been active on the linear side. It has built a relative value tool that gives traders in predominately voice-traded products a way to quickly see the price of more liquid correlated instruments. This enables the traders to respond to RFQs more easily, and indicates if an asset is dislocated in relation to its hedge.

Barclays’ European government bond business was one of the tool’s main beneficiaries. The desk had fallen a little behind its peers over recent years, but the relative value tool, along with new hires and increased balance sheet capacity, gave it a boost in 2023.

Barclays also made significant investments in the desk’s technological capabilities. The bank built new pricing algos that allowed for quicker auto-pricing of electronic RFQs and faster distribution of axes to clients.

Barclays is now ranked number one by Bloomberg and number two by Tradeweb for in-competition trades of European government bonds, having previously been at fifth and eighth place respectively in 2021. Average daily tickets for the EGB business also rose by more than 300% during the first half of 2023 compared with the same period in 2021, while the average DV01 per ticket increased by more than 275% over the same periods.

Barclays’ US business also had a role to play during the crisis that followed the collapse of Silicon Valley Bank. When the Federal Home Loan Banks needed to raise money to shore up regional banks against further liquidity problems stemming from deposit flight, Barclays issued more than $300 billion in short-term debt in the week beginning March 13.

The bank has a strong presence in short-term US rates and took down roughly a third of the issuance that week, which it quickly distributed to its client franchise. “It was a shocking number for someone that was fairly new at the firm,” says Orlando.

Shocking, but not surprising for a business line that has proved its ability to turn the most unpromising situations to its advantage.