Hamlin Lovell: Is Soc Gen really growing its market share in terms of priming equity-related hedge funds?
Ted O’Connor: We certainly are, thank you for the question. We’re growing our equity prime brokerage. We think there is a unique opportunity for us to take advantage of what is a rapidly changing dynamic in the market place where there have traditionally been a number of entrenched leaders. We find ourselves in an enviable position where we have the balance sheets to be able to transition the firm to more of a hedge fund focused business. So we think that there is a great opportunity for us in equity prime brokerage. We continue to go out and tell our story and add clients to our platform. There’s going to be a very significant opportunity in the next couple of years to take several hundred basis points of market share and compete with some of the bigger providers in the space.
HL: Are you still sticking entirely to liquid investment strategies or are you also starting to branch out into less liquid areas such as credit convertibles, high yield or even distress debt instruments?
TOC: We would certainly want to focus on equities, although we do look across the entire asset spectrum of a hedge fund. As we think about shaping our business, a big part of it is the balance sheet allocation that we have. Couple that with our ability to provide securities lending from across the asset spectrum as well as our ability to cross-margin with everything physical and derivative, we think that brings us a unique solution. So we can go into the whole asset spectrum, whether it’s equity long/short managers, value managers, what they call trading macro, credit, even the FX space, we can bring together a solution across the spectrum. Today, it’s really about going out and funding assets at the right price and getting a return on those assets. So long as we can keep the balance sheet to meet those metrics, then we’d be open to having discussions with hedge funds across the spectrum about how we can work with them.
HL: And are you also still growing market share in your core activity of clearing listed derivatives?
TOC: We absolutely are. If we look right now, we trade about 12% of the world’s derivatives on a daily basis. We clear over six million transactions, but there’s still a large gap between us and the top two providers in this space, so we firmly believe we’re number three. If you look at the exchanges, they’ll both validate that. But there’s a gap of almost double from where we are as number three to the number one leader in the space. We continue to invest, we continue to find ways to clear new products, whether it’s cleared across equities, FX or credit. As a matter of fact we’ve just cleared our first credit trade in the last handful weeks. We think it’s a wonderful opportunity for us to continue to go and be creative and innovative about the way that we help clients fund their portfolios and record those transactions.
HL: Well, that brings us onto a very topical area. How many types of OTC instruments do you now clear and which new types of instruments are being on-boarded as we speak? We know for example that non-deliverable forward currencies have recently been added.
TOC: When we look at the interest rate swaps we’re clearing both here on the CME and the LCH in London, we’re doing iTraxx on the credit space, and credit indices on the CME across all 18 currencies that are available. Then you mentioned in the NDF space where we’ve recently done our first transactions as well; we do think there’s an opportunity for us to grow market share there. We think that it’s worth investing for the future. As we talk to our clients, we hear a need for firstly a central means of collateral, because we are seeing regulation requiring more collateral for these instruments – they are traditionally traded bilaterally with banks and now they’re going to be moved towards a central clearing house. It’s going to require, in many cases, for the first time collateral to be posted to those trades, so collateral efficiency is certainly integral to making that happen. Then the second piece is pricing, where we used to have in the bilateral world a pricing mechanism, either on a daily or weekly basis, where you would agree to a price and they’re priced into a portfolio. Now we’re going to be mandating to where we have a central clearing price that will be priced on a daily basis. We think that the future will be central clearing houses.
HL: So how big are the advantages of clearing in terms of margins, capital efficiency and operational efficiency?
TOC: When you talk about capital efficiency, I think it’s also one of the very prominent themes that we hear in the hedge fund universe right now. There are a number of external service providers for public hedge funds that think about where they allocate their trades, where they’re going to get the most efficient capital treatment, and what the cost of funding is going to be for that asset. So we think that the hedge fund universe is becoming increasingly more complex, but also at the same time, more in tune with how the regulations are making them reshape their portfolios.
We think that we can take advantage and be a real asset to our hedge fund clients. We have an internal system called Pulse, which is available to our clients. It was developed on a backbone of being an FCM, which if you think about it, is a more sophisticated way to build a client portal. It was built on real-time trading, real-time acknowledgements of trades, built-in margining of those trades and we’ve been able to do that across the entire asset spectrum. So we started with futures, we’ve been able to add FX and rates capabilities and given the recent changes in the credit market place, we’ve been able to incorporate that as well.
When you bring all that together with equities, we think that we offer a really unique solution that allows big complexes to be able to trade the entire asset spectrum, to settle and include their trades and have transparency into what’s happening in those trades and to ensure that they are avoiding the sins of settlement clearing wall, which is breaks, by seeing a system with real-time acknowledgement of those trades. This facilitates understanding of where your open trades are, so you can clear as quickly as possible.
HL: And is Soc Gen’s pool of security inventory also helping to attract new clients?
TOC: It is indeed. Soc Gen has traditionally been a wholesaler of securities lending. We’ve been active in that market for a very long period of time. What that’s done is to leave us with a pool of several hundred billion dollars worth of inventory to be able to lend to the hedge fund universe. So what we’re doing is just porting that inventory from what was a traditional wholesale model to one where we are in business of lending directly to institutions. If you think about the nature of what Soc Gen traditionally has been, it has really been a derivative house, so this bank has traditionally been a long inventory because of the derivative nature of the trades and it’s going to bring a significant synthetic book as well. When you couple that with everything we have on the platform, we have some rather exclusive inventory here and if you think about the nature of the indices that we do our funding in, we’re able to have a long tail of inventory to be able to lend to hedge funds who are trading outside the Tier 1 equities.
HL: How important is Soc Gen’s research offering in terms of macros, single stocks and quant research?
TOC: We take a very differentiating view of research and it’s core to our DNA. If you think about correlations that have arisen over the last couple of years across asset classes, we think that we have positioned ourselves to take advantage of that. So whether you think about this place as being a macro-research house, commodities-focused house, an FX house or an economics house, we’ve come up with a great blend across the whole asset spectrum. It has allowed us to be differentiated in a way that we help managers to think about what’s going on in the world today.
We certainly have research analysts. Wei Yau who focuses on China has a very differentiated call – she’s been calling for restructuring of the credit universe there and we think that she will have an impact on the way that the Chinese authorities think about repositioning their credit. Then being a European banking house, we’re seeing epic changes at this point in time in Europe and we have a very deep bench of analysts and economists who are very close to what’s happening in Greece at this point in time. We think that we can be influential in helping the hedge fund managers across the universe think about how to navigate these big changes in Europe.
HL: How critical is the execution efficiency for hedge funds today?
TOC: As I talk to hedge funds, I think one of the most prominent themes probably is best execution. What we’ve seen over the course of the last handful of years is about a 40% reduction in liquidity in the US equity market place. We’ve seen regulations impact the amount of inventory that banks are holding of credit and rates products and what that’s meant across the asset spectrum is there’s just less liquidity on a daily basis. So finding pockets of liquidity, being able to execute a shorter-term strategy, is really a critical element of the trader of the hedge fund universe. What we’ve done here at Soc Gen is a couple of different things. One, we believe that there’s an awful lot of inventory, it’s moving through electronic channels, so we have a deep pool of quants who work with our alternative trading teams to develop algorithms to help them, whether it’s a T-WAP or a V-WAP or probably more importantly limitation shortfall or trying to beat the entry or exit prices to help fund and navigate the markets electronically and be efficient as possible. But it goes beyond that, we have a team of advisers here who can help a hedge fund think about what’s the most appropriate strategies to deploy at a given point in time. We’ve seen a very significant shift across the asset spectrum. If you look at the equity world alone, almost 20% of the daily buying occurs in the several minutes of trading on any given trading day, so a manager who is trying to move in or out of a very large block of stock has to think about when is it going to be an opportune time to move in and out, how much market share do they want to do in the last parts of the day and how much of an impact do they want to have on the closing price? We have a deep team here of people who are studying markets every single day, working hand and glove with our quant team and providing solutions to the hedge fund managers.
HL: So it sounds like you have a very comprehensive offering, can you really offer a one-stop shop in terms of clearing, execution, financing, research, custody, or are there actually a few gaps in the coverage that you might be looking to fill later on?
TOC: We’re offering a pretty comprehensive solution for the entire life cycle of the trade at this point in time. So from pre-trade analytics, helping a hedge fund manager think about the impact on the market place, to the execution, the settlement, the clearing and the funding of that; we’re offering solutions right down the entire life cycle of that trade. We would think about funding our trades, that’s becoming a more complex transaction as we have portfolio margining and VaR margining, and as we’ve talked about, you see more and more instruments move to central clearing houses, so we think that we have the ability, given the history of what this bank are all about, to look across the whole asset spectrum and not just think about funding a single asset, but more importantly think about funding the entire portfolio. We believe that the DNA of this bank and its culture allows us to have an edge in being able to think about how to make that happen. We think that’s one of our really strong selling points here.