Credit derivatives house of the year: JP Morgan

To the casual viewer, credit markets were stagnant for much of the past year, with volatility muted and spreads grinding steadily tighter.

On closer inspection, though, isolated market disruptions have opened opportunities to investors and banks with the tactical smarts to profit from them.

JP Morgan was one such firm.

“It’s evolved from a one-dimensional market environment predicated on fundamentals to one based on game theory and tactics,” says Andrew Crook, global head of leveraged finance sales.

JP Morgan’s strengths in credit were on show with its trading activity in telecom operator Altice. When the highly indebted company announced in March that funds from asset sales might remain inaccessible to creditors and noted they would need to accept sizeable haircuts on their holdings, traders rushed for the exit and debt prices plummeted.

We’ve gotten better at providing equity solutions to our clients

Jake Pollack, JP Morgan

In the flurry of activity that followed, JP Morgan captured a quarter of single-name credit default swap (CDS) trading volume across the three active Altice contracts in the year through September. The bank was responsible for 26% of Altice loan and bond trading over the same period.

The episode illustrated how JP Morgan’s deep client rolodex, extensive sales force and ongoing client conversations have proven profitable for the bank. Throughout the year, the bank’s credit derivatives business continued to capitalise on investments made to the cash credit side of its offering, blurring the separation between the two product sets in terms of risk management, sales and client interest.

Portfolio trading investments fuelled growth in total return swaps. Exchange-traded fund pricing enhancements set the stage for options on bond ETFs. ETF options in turn created opportunities for options trading on CDS indexes. Growth in one product stimulated growth in others, in a self-reinforcing loop.

“We are reaping the reward of what we have sowed these last few years,” says Olivier Cajfinger, global head of investment grade credit sales, short-term fixed income, and public finance distribution. “This year we have seen the broad set of the products getting larger and larger and our market becoming more and more complex.”

Synthetic success

During the past year, JP Morgan has received strong demand for what it refers to as tranche products, structured credit trades that divide risk into baskets and compensate buyers based on that risk. The instruments range from collateralised loan obligations (CLOs) and synthetic risk transfer, through to collateralised synthetic obligations.

Collateralised synthetic obligations offer exposure to credit risk via a tranche of a CDS portfolio, either a custom basket of issuers or a subset of those comprising the major indexes. JP Morgan’s credit desk handled 25.6% of the $179 billion index tranche market through the third quarter, according to its internal volumes and Depository Trust & Clearing Corporation (DTCC) figures aggregating transactions on North American and European high-yield and investment-grade indexes. Its market share for 2024 represented a nearly 4 percentage point increase from last year and a more than 7 percentage point jump from 2022.

JP Morgan’s progress in this market is again attributable to joined-up thinking across different disciplines, or a “holistic approach”, in the words of Denis Gardrat, global head of credit structuring. In risk management, for example, the team managing macro index products and the one looking after more bespoke products work together to offset each other’s risk.

Juan Reig Mascarell, global head of alternatives, solutions and exotics credit trading, says: “The integrated risk management approach across that product spectrum helps get everyone comfortable that you can warehouse the risk because you are going to have an exit for that risk because of the distribution network.”

In CLOs it was a similar story: a growing market share achieved through cross-desk co-ordination. JP Morgan gained a percentage point of the US new issue market share from 2023 and maintained its spot atop the US leaderboard this year with a 12.8% share, Bloomberg figures accessed in mid-November show. In Europe, the bank jumped from fourth place to first, climbing 7 percentage points, to 20.3%, in market share as it more than doubled its volumes.

The success is down to two factors, says Jake Pollack, global head of credit financing, CLO primary and direct lending. One, an effective partnership with the bank’s secondary trading desk, which helped issuers place tranches with investors. Two, improvements in how the bank sells CLO equity in a market that a year ago saw scarce opportunities to finance a deal’s riskiest segment.

“We’ve gotten better at providing equity solutions to our clients,” says Pollack. “Twelve months ago, CLO equity was very scarce. It was tough to raise capital. We spent a ton of time building out capabilities – internal and external platforms that give our teams solutions to sell equity for our CLO investors.”

The team relied on the bank’s sizeable balance sheet to hold the safest tranche layer, as well.

“We took a risk view that we really liked the opportunity set – and we wanted to support our client franchise – so we leaned in with our balance sheet. We like the risk-return of the triple-A asset right now, so we’ve chosen to hold a lot of it,” says Pollack.

Loan rangers

JP Morgan’s loan portfolio offered another opportunity to give clients credit risk exposure, this time through synthetic risk transfer, or SRT. The transactions enable banks to offload credit risk on private loan portfolios, gaining regulatory capital relief in the process.

The product sees banks buy first-loss credit protection on loan portfolios, potentially with a special-purpose vehicle sitting in between them and investors, and typically funded through an issued credit-linked note.

The US SRT market received a jump-start in September 2023 when the Federal Reserve issued guidance that clarified the type of credit-linked notes that were acceptable for capital relief.

We’ve shifted from a capital focus to a risk focus with SRT

Masi Yamada, JP Morgan

The underlying pool of loans covered by SRT deals is estimated at €207 billion ($217 billion) last year, with protected tranches totalling more than €18 billion, according to a survey by the International Association of Credit Portfolio Managers. UK and European banks issued most of the volume.

JP Morgan finalised a deal in December 2023 with five clients to sell the bank $2 billion of protection on a $22 billion portfolio comprising investment-grade and high-yield revolving credit facilities with corporate clients. The deal was structured with a cash-collateralised special-purpose vehicle. Other transactions saw the bank buy protection on over $10 billion of its sponsor subscription lending facilities.

“We’ve been building our SRT programme for the better part of four or five years, and as soon as we had clarity from regulators last year, we hit go and executed a series of large transactions,” says Masi Yamada, head of global investor structuring and local markets solutions.

Yamada says the demand stems from an increasingly sophisticated investor base capable of quickly analysing corporate loans which – given that the SPV structure means JP Morgan needs to execute deals as bilateral transactions with each counterparty – reassures the bank that selected investors understand the risks.

Even as anticipated bank capital needs decline, Yamada still sees a future for US activity. The bank has continued to strike deals in 2024 but declined to offer details on private transactions.

“We will not have a capital issue for some time now, as we’ve spent a lot of time and energy to build a buffer. We’ve shifted from a capital focus to a risk focus with SRT. Where it’s prudent for us to hedge the risk of our portfolios – and it makes sense from a return perspective – we have continued to pursue transactions. It’s resulted in smaller transactions and more targeted and higher-risk transactions,” says Yamada.

Swap shop

As with the bank’s strength offering risk transfers, its ability to price total return swaps (TRSs) on bonds and bond portfolios stems from years of investment. For TRSs, which allow investors to gain credit market exposure without owning the underlying assets, this investment focused on its cash business and portfolio trading specifically.

The trading method sees banks price hundreds of bonds to execute as a single transaction, sometimes with a mix of buy and sell orders for a client. Doing so quickly relies on sophisticated pricing tools, and risk-managing the resulting positions means finding offsets for the growing flow. TRSs have offered one potential outlet. The cash trading method has helped the derivative product grow, too.

“Some of the price of the swap is derived by your own cost of funding, being short or long. The more you internalise the cash product, the more competitive you can be on the swap. A large number of accounts use portfolio trading, which has allowed us to have a more two-way market on a swap format. Creating volume around portfolio trading reinforces your ability to provide the same exposure via swap,” says Mascarell.

The bank’s market share for swaps on the dollar-denominated investment-grade iBoxx index jumped 8 percentage points, to 42%, between 2023 and the first three quarters of this year, according to the bank’s calculation of DTCC figures. The share for swaps referencing leveraged loans rose 10 percentage points, to 27%, in the same period.

The bank’s non-index bond TRS book nearly doubled in the second quarter from a year ago and was 75% larger in the third quarter, according to comparisons of average monthly gross outstanding notional for each period.

Clients have noticed the difference. “Most shops have shied away from it,” says a buy-side credit derivatives trader. “JP Morgan actually made an investment in it and made a concerted effort to make markets. I don’t even bother calling anyone else any more, quite frankly.”

Before sending an order to the desk, the bank offers clients the ability to preview its pricing on bond baskets through its Vida platform and compare the prices for trading the portfolio on a cash or swap basis. When it comes to establishing a short position, TRSs can help clients avoid having to sell bonds into a potentially illiquid corporate bond repo market.

The right option

The bank has also made a push into markets where it hasn’t been the biggest player. Credit options is one such example, where the bank has achieved what it sees as sustainable growth by combining trading for contracts referencing credit ETFs and CDS indexes.

Rémy Yazigi, global head of macro credit trading, says the bank has committed more to CDS options than it has in the past, while also expanding its ETF options trading.

With $571 billion notional passing across the desk in the first three quarters, the bank has already traded 76% more than it had during the whole of last year for options on the North American CDS index family, CDX.

“Being able to trade all these underlyings under the same pod helps our liquidity provision in CDX in particular. ETF and CDX options are very correlated – the underlyings are very close to each other,” he says.

Yazigi says the gains can also be attributed to changes that have reduced the amount of initial margin clients post to trade with them, which for some clients stems from modelling based on portfolio exposure.

The index swap business has shown less progress over the past year with the bank maintaining its second and fourth place rankings for Bloomberg- and Tradeweb-executed transactions on North American and European indexes, respectively.

For swaps on the investment-grade and high-yield North American indexes, the bank dropped 3.8 percentage points in market share, to 15.5%, for combined trading on the two platforms through the third quarter compared with trading last year. The 2024 share puts the bank roughly at its 2022 share. On European indexes, the bank’s market share through the third quarter remained largely unchanged from last year.