Lynn Strongin Dodds explores the challenges interest rate dealers face in maintaining and attracting new clients in an increasingly competitive environment.
Interest-rate derivatives (IRD) dealers face an uphill battle to retain and win new clients as volumes are coalescing among a select few players. While cutting edge technology and innovative products are essential, these firms should not underestimate the importance of relationships, according to a new study by Greenwich Coalition.
The report – Derivative Investors’ Expectations for Sell-Side Technology and Services by Coalition Greenwich – was based on interviews with 368 buy-side IRD traders globally during 2023. The aim was to ascertain their views about key issues in the market, including improvements they wanted to see as well as the triggers that could put a relationship with a dealer at risk.
“IRD dealers face a host of challenges, including regulatory mandates governing capital, competition for talent and the need to constantly invest in technology,” says Stephen Bruel, senior analyst in the market structure & technology group at Coalition Greenwich and author of the report. “These forces can erode the quality of service if not managed closely—if a dealer loses top traders or underinvests in technology, their clients will notice and can redirect flow to other banks.”
End users can be fickle, but dealers cannot afford the switch of allegiance in this fast moving and competitive market. The report cites data from the International Swaps and Derivatives Association (ISDA) and the DTCC, which shows that between 2022 and 2023, IRD notional volume traded jumped 11% to $324.5 trn, while transaction count rose10.9% to 2.5 m.
However, these numbers are misleading in that despite the robust growth, there is not enough business to go around. Research from Coalition Greenwich showed that during the same time period, IRD dealer revenues fell 9% from $8.77 bn in 2022 to $7.96 bn in 2023 for the leading 12 banks. Activity was also becoming increasingly concentrated with the top four accounting for 63% last year, up from 61% market share in 2022 while the bottom four comprised 12% of revenues slightly higher than the 11% the previous year.
Typically, IRDs dealers hope to engender loyalty with an array of new, shiny tools and products. In fact, the report notes that the investment spend on technology is growing at a faster rate than other areas such as operations and administration. However, while the technology can cement a relationship it can also impair it if the promises do not deliver the goods or enhance the service or processes.
This is particularly true with pricing where 34% of respondents place it top of the IRD dealer selection list. The report says that for dealers, pricing is not only a technology question but also one that involves risk management, credit allocation and other factors. For end users, though the main areas of focus are the level of pricing and how it compares to its rivals. Technology can be an enabler by providing bids and offers with a smaller gap with more timely quotes and real time prices.
The quality of trading and sales coverage was also a main driver for 31%. The report found that this is assessed more qualitatively by end users, but the level of service is a key determinant. In their choice of dealer. The calibre of the individuals is seen as paramount because as the report notes, end users are looking for” touchpoints, more interactions with the trading desk and the research team” and they notice “deterioration in their service.”
This is not always an easy path for IRD dealers to navigate. They are expected to deliver less expensive services with superior coverage while they are still grappling with financial implications of regulation and changing market dynamics. This has put pressure on margins, resources and can strain relationships for both the desk and the individual clients.
The buy side also has its work cut out. As Bruel points out, firms are on a journey to improve and optimise their trading. A chunk of their focus needs to be on their own technology, portfolio management, research, operations, and trading processes. They can be supported by their brokers through a focus on pricing, and improved service quality and technology.
“Not every buy-side investor will get all they want from their brokers as many brokers may have different priorities, but responding to the buy side’s wish list can help sustain a dealer’s IRD franchise,” he adds.
