As market volatility has literally lulled to sleep many global trading desks, there is a growing awareness of those that seek to be prepared when the change occurs. “Brokers in this market would love some volatility—whether it came from a spike in investor conviction or fear,” Greenwich Associates Managing Director Jay Bennett observed. In a recent survey, the firm noted who is ready to reap business when volatility once again returns to markets.
Volatility will return at some point, its just a matter of when
Volatility is one of a handful of market environments that has among the shortest return tail structures of all. It can be difficult if not impossible to forecast because, by its nature, volatility involves surprise. But when volatility does strike there are typically multiple interconnected trends and price correlation relationships that are impacted.
“It’s a very dangerous world out there,” CMEGroup Chairman and CEO Terry Duffy told CNBC recently. He thinks that while event risk at home and abroad has not moved markets, that soon could change. Even in a low volatility environment, he says increasingly investors are looking to hedge.
For the derivatives markets and their largest players, this can be a critical component of their success.
It is here Greenwich puts together its list of potential winners when volatility does return.
Goldman Sachs is the derivatives market leader
“The U.S. stock market is smashing records on a near daily basis, and equity markets around the world are strong,” a market environment that occurs with historically muted volatility. “The lack of volatility reflects and has contributed to a sustained downturn in trading volumes,” the Greenwich report noted, pointing to one side of the bank brokerage business model.
“Although strong equity markets and low interest rates are prompting investors to take money off the sidelines, more and more investment assets are flowing into index funds that don’t require the trading and hedging activity inherent in most active management strategies,” the report noted.
The passive investing trend is mimicking the muted, listless market environment and has been lulled to sleep, pushing demand into the basement. But the largest banks are not giving up hope as “sluggish demand” has not diminished their commitment.
The top brokerage firms, led by Goldman Sachs, are “defending their positions to be ready for an uptick in volume in this critical, and in spots highly profitable, business.”
Goldman Sachs and Citi are leading the equity options and volatility products, while Goldman is the clear leader in equity swaps, with Bank of America Merrill Lynch, Morgan Stanley and J.P. Morgan all in a virtual dead heat in second place.
Goldman, known for its deep client relationships, is the clear derivatives leader, also topping the list in equity futures, with Bank of America Merrill Lynch in second place.
“Once you get past the top firms, brokers generally go one way or another—they target broad market penetration or a deep share of wallet among select clients or products,” Greenwich Associates Managing Director John Feng said in a statement. “The Greenwich Leaders do both.”
So what makes a leader a leader?
Greenwich Associates research shows a large historic correlation between relationship penetration and quality of service in flow equity derivatives. The reason: When market participants are choosing a broker for a trade, the main drivers of that selection process are: 1) Pricing and execution, which includes broker capital commitment and accounts for nearly two-thirds of the decision; and 2) Sales coverage, which accounts for about 15%.
All told brokerage decisions for derivatives transactions are about quality, however, and not just pricing, says Greenwich. When the next spate of market volatility inevitably returns – which Duffy knows is just a matter of time – these “Greenwich leaders” are set to benefit.