The big shifts: Street-level insights from the trading desk

hi I'm Jason lenzo and I'm joined here with senior colleagues from our trading and implementation team we're going to share some of what they are seeing in the client portfolios and the market dynamics as well as some of the upcoming changes to the investment and trading cycle let's start with allocation to private markets Greg many clients here are well overweight and looking for options to expose and rebalance at some point and kind of wanting to see some of the solutions that you're seeing from your clients and the portfolios and what you're what you're able to provide sometimes those shares get locked up and can experience price pressures when those come out of lock up and get traded in the open market so you you got a pretty interesting view into the client's portfolio and their allocations as well as some of the challenges that this Market's providing yeah thanks Jason the last few years have really been interesting because you've got commitments people increasing allocation to private Equity you've got low distributions uh just from a historical perspective uh and then it's kind of the immovable object can't rebalance out of private Equity so you have this growing asset class the rest of the portfolio is starting to get dominated by it there's really no Silver Bullet for attacking that allocation challenge with private or with public assets using derivatives or or other listed Securities because you're trying to take it down it's expensive to sell so most clients have opted not to so you're really left with you know kind of Creative Solutions to proxy risk assets with their derivatives and you know for most clients they can't use leverage um but one of the more interesting Solutions we've seen is clients that can use leverage uh looking to top up some of their public assets equities fixed income just to balance out the risk profile of the portfolio uh not maybe all the way but just kind of get a little bit more balance from that massive over so that's one area we've seen kind of help clients with Creative Solutions um you know I mentioned the low frequency of distributions historical with the ramped up commitments someday soon we're going to see many more distributions coming when we do kind of look at the past uh there's been a lot of chunky IPOs the unicorns that uh I talk about clients are getting distributed in shares rather than cash right they want the cash to reinvest but they're getting shares and they're stuck with them sometimes they're on a six-month lockup and so they're dealing you know needing to figure out a strategy to liquidate this um so hey Lisa if you want to discuss some of the strategies help clients navigate that right window of uncertainty before liquidity as we work together really I would say probably maybe the last four years like since coming out of covid can't believe it's been that long but there have been a number of different inquiries and challenges that clients have had so each is very specific to this situation right the type of holding that they have or the risk that they're specifically trying to mitigate so just as you said and I can think of one prominent example we had um a a us-based domicile client who had private Equity exposure that uh that turned into an IPO that was very successful overseas in Asia and then the question became oh my gosh we're in a lockup but we do need access to that cash how can we plan and also hedge so that at the appropriate time it becomes we could liquidate it but for right now what do we do to hedge and so there have been a number of different options and derivative strategies that are teams have collaborated on depending on the client and a specific situation um put spread callers so assuming you're long the underlying you identify the spread on the puts that you would like and then um and then plug basically the call uh to figure out what your exact entry point is those are just that's just like one specific example of something that's come to fruition that we've been able to do for a client and then that also has taken us into a timeline right it not only becomes okay so you have this this event but how do you diligently based on the number of shares that you have um I don't want to say dollar cost average but really that's sort of what it was right how do you in a very disciplined manner take that exposure and then and then liquidate it to the satisfaction of the client so that's one example in the private Equity space of course we have other examples that are not private Equity related that are also protecting or interested in Crash risk in mitigating other risks that are not specific specifically designed to uh hedge a private Equity event and even on the fixed income side obviously there's some you know some Bond Holdings that we could hedge with a credit to single name credit default swap so it runs the gamut and what's has been really interesting is the volume and the uptick that we've experienced that particular segment of the marketplace more recently and that and actually that doesn't just include derivative so then as I had mentioned just a moment ago it's what do you do with that when that lock up per and those specific derivatives are uh have matured or expired uh then then it becomes a liquidation event for the Securities underlying in which case then it becomes uh equities or fixed income that that are liquidated so yeah no absolutely we have this growing amount of asset owners who effectively have you know private uh equity and Venture Capital exposure in these markets and as they as they grow and mature these Investments they OB obviously the the end point could be IPOs and uh moving into the public markets um and and many of these asset owners effectively want to reinvest this this these Investments and so uh they actually looked to us in the public space to go about there and go out to the market and and execute these in the most efficient fashion um many of these are very very high touch Securities they can be very difficult to trade you're dealing with a situation where there's a lot more participants in the Market at a given point in time at the start of this um and really our research has kind of indicated that there's a very fairly heavy self pressure in the market in the first few days of these these lockouts when they get settled and matured with the uh the custodians and so we've worked very closely with our clients and stuff to effectively make sure there's guidelines in place to help protect this Capital um and really implement this liquidation over more of an extended period of time so from what we've seen uh as our slides and research indicate that the first five days we have a heavy selloff um that these these Securities are are down below the distribution price from custodians down to 24 25% but over a period of time of of 30 days to 40 days we've actually seen quite a bit of a regression that these prices and stuff uh get washed out from the sell pressure and then uh effectively move back up into the pricing so um we work with our clients quite a bit to just effectively make sure we've got a fairly passive and effective way of implementing their guidelines that they'd like done so that we can you know retain most of that Capital really interesting research and I think we have a question kind of changing gears here a little bit uh we have a question for the audience about um the t+1 shift that's occurring on the 27th and 28th of May just coming up um but before that we have a question on um you know do people think that we're going to eventually shift from T plus1 to t plus Z and so we can talk about that a little bit it looks like we've got about uh 55% of the participants are thinking that it's going to go from T plus1 to t0 uh inside of three years uh 36 say no and about almost 10% say yes in 10 years but before we talk about t0 because that's well in the future that SIM can you talk a little bit about some of the changes that are coming up I mean a few years ago we moved from T plus3 to T plus2 and that was you know the Market's weathered that storm pretty well but you know there's some differences when it goes from T plus2 to T plus1 just because the global clock gets compressed timelines and cut offs so and what are your thoughts and views on that from a currency perspective absolutely so as you mentioned and I really do that we have it all figured out before we move to tter I'm sure we will um but you know like you said Europe first changed there settlement cycle from T3 to T2 back I believe at the end of a um at the end of 2014 and then the US followed through thereafter from T going from T3 to T2 um early on in 2017 and during that shift you know a lot of the investors did learned that if you're a global portfolio manager and if you're um raising cash in one region and um you're using in another region you have to make sure those settlements align so that issue I feel like has been ironed out however the big issue here or the challenge that I foresee here going from T2 to T1 at the end of this month is uh just the fact that um the the global clock like you said and it also doesn't help that the US or the North American region is the first movers in this instance relative to you know back a few years ago Europe moved first and so with that said as well you know we have a 24-hour clock obviously and if you can move on to the next slide with uh the currency part um we um there is you know currently we have 24 hours plus a few hours for you to um to match Securities trades with the Brokers and calculate out what the fees are to make sure you know exactly how much FX needs to be done to settle those security trades and then from there you have to do those FX traits and then from there you have to push it through the selement to settle those FX traits be it in CLS or grow settlement bilaterally now you have 24 hours plus a few hours now but come May 27th May 28th that 24 hours plus some becomes just the plus some few hours in order to get all of those four points done now that is not a lot of time especially if you're looking to settle in CLS so I do do see there's three main challenges that we'll foresee one of them being settlement risk if you decide to foro CLS settlement which a lot of people will do because if you're sitting in the Mia or you are sitting in the UK and 4 P.M us you know the North American stock market closes it's already 10 p.m. so most people will hopefully be enjoying their evening or anyone like myself already be in bed and with that said you know you if something goes wrong with CLS settlement let's say everything is straight through processing but something goes off you have to be able to Pivot to settle grow settlement against your bank um your broker so you need to be staffed and if you don't have that staffed then sure let's just go with the gross sell right out of the gate so then that means you have to have your ssis update and alert constantly for all the currencies that you're trading and so that is the settlement risk part the second part that I see as a challenge is um uh the the liquidity as I mentioned so the bottom part of the chart you can see that in those two hours after the North American Market Clos and well in one hour the trade date rolls over to the next trade date so you're essentially already at t plus Z at that point and then you have one more hour before you make that CLS cut off time now with that um if you can see that's called The Witching Hour where there's absolutely no liquidity especially on a Friday usually on a weekday you would have the North American traders pass their books on to their Australian counterparts sure they can keep the book going but no one wants to hold overnight over the weekend risk so on Friday liquidity really dries out what that means is okay investors will quickly try to do those trades during that 2hour time per one hour time period you call your bank and say hey can you make sure your Traders are still around to make sure you actually get to get get to have the FX done but the the um the market the the liquidity everything will widen so your trade cost will essentially go up so that's the second point and third um which I think is the biggest challenge which hopefully won't come very frequently is around Market all as know in currencies you're working in two different regions so let's say you are um an investment manager in the US and you're managing money for for super annuation fund for example so your operating currency oy dollar and say today is your trade day you're purchasing some us equities and t+1 is going to be today being already t+1 in let's say June and there's an Australian holiday with t+1 that's actually happening on June 7th uh Friday is the trade day June 10th following Monday will be your settlement date but it's an Australian holiday and June 10th it's a king's birthday and so when that happens the purchase of USD that you have to make using your aie dollar funding that settlement will change to t plus Z but at the point of 4M market closed it's already tomorrow it's already the weekend in Australia and you've already missed the aie dollar cut off the custodian cut off it doesn't even matter if it's CLS or nons you've missed the cut off so people I guess the solution or the resolution around that are where people are looking to either pre fund which is obviously not a very popular thing to do um or not trade around those holidays which is also opportunity cost well so why would you not you know avoid just because there's a market holiday and the other one that people have actually been trying to do is to change their operating currency from Australian dollar to let's say USD Canadian dollar or Mexican peso depending on the region that you're trading so with that said you know if you want to prioritize CLS settlement um and if you have if you're an investment manager in a Mia we have had a lot of clients reach out to us and say hey what's the good solution for that and the fortunate thing for Russell is that we're sitting in Seattle so want you know 4 p.m. stock market closed for us it's only 1 p.m. we're fully staffed so we have had a few clients reach out and say hey can you just can we just Outsource all of our trading and middle office and all that functionality through you guys and we do have a big equities desk here in Seattle and so we um have had a few clients that said you do the US Equity trading and then the FX and all of that stuff can you just take care of everything and so everything setts in CS absolutely and the trade cost as well with us competing our flows out and having good relationships with the banks we're able to keep the trade cost down but still with that said I still do think that this is a bigger challenge that what we foresaw uh uh back in 2017 Nat toi there were several calls for CLS to extend their deadline did that actually that fell on De ears so that that will not change in your timeline that's correct so for the time being so CLS has I believe about 70 members they had to get a vote from every single one of them and I guess the consensus or at least the majority said hey there's a lot of Technology changes that needs to be had at those Banks so the most of them I believe said hey let's not do it this time around I don't think it's something that was completely thrown out of the window but for the time being come May 2728 CLS is not looking to extend their cutof time but that's a good point one thing about that is even if you do extend CLS cut off time if you're custodian Bank let's say it's located in Asia it's really up to them they have their own cut off time be it CS or gross settlement if they dictate the cutof time you're basically your hands are tied um with the custodial cut off times we've had a number of inquiries in terms of how t+1 will actually impact derivatives and of course a lot of derivatives are and have been on t+1 especially listed for quite some time but in the bilateral space we've received a number of of inquiries and of course you know sometimes there's a currency component in that too that you're trying to match up depending upon what you're trying a hedge and so by and large a good metric for what we've been guiding clients on is if you're and again North America is moving again to t+ one as of uh the day after Memorial Day in the US which is Tuesday May 28th and is Nazi me alluded to before the US was playing a little bit of catchup when they got into the situation in 2017 going from t plus 3 to T plus2 and then of course I mean it was year I mean 1993 is when we went from t+ 5 to T plus3 right so it this is a very compressed time frame that Regulators really since the um meme stock craze have been very focused on settlement risk right so all of a sudden it was this accelerated pattern and with the us moving this month it's like that is the reverse of as Naim had highlighted what had happened several years ago in 2017 So within the last month I do find it encouraging that um Majesty's treasury has come out with this accelerated task force timeline of providing a mandate for the way that the UK will operate um requiring that in 20 2025 to be announced with an implementation date um ideally well before the end of 2027 so and the the purposeful guidance there of working with the EU so that UK and EU can ostensibly hopefully move very quickly thereafter okay so but if you have bilateral exposure and what what are you going to do this month well if you have that on and those trades are on right now General as a general rule you'll be abiding by te list too because that's where at the start of the trade where you were if you enter into anything on Tuesday uh the 28th or later you will be abiding then by uh t plus one and this is a function of the underlying of course because derivatives are always based on some type of underlying so if your underlying is moving then your trade will move but if you're reset if this trade started before and you have resets or maturity that's after it you'll be on t+ one but I would also encourage people to reach out to those trading counterparties who they face and have many exposures with to make sure because technically the bilateral OTC space is not is not defined as a security right so it's important to be on the same page as as your trading counterparty in the bilateral OTC space and that of course leads to the discussions that um well in the around the globe I mean you have China and and India now trying to move to well China I guess with stock uh stock and then uh cash t plus1 and India trying to move to uh t plus Z but those are a little bit different Market situations and so the biggest highlight that I heard when once we were moving to t+1 was of course the implication for FX and that has knock on implications for your derivatives exposure if you're marrying the two as frequently you are and then of course um everybody was like well what about like ETFs and all these baskets of underlyings that could have international components and again on the derivative side if you've got that bilateral exposure on a basket it's going to be your longest settlement that's in the basket that's going to is really what you're predicated on but those were some of the big things and so I Brandon what if what how is this impacting equities and and fixed income securities yeah I think for the most part on the the equities and fixing but it hasn't been you know overly extensive as as FX Has and and derivatives really have um in the in the equity space I think a lot of it has been kind of uh muted a little bit from the standpoint that there's there's you know uh products out there like ctm and things like that to help with the settlement standpoint to be able to match and and handle any type of shorter time frame to be able to uh to match counterparties from the equity trading standpoint and then on the fixed income space you're really just simply dealing with you know a change of a crude interest um that gets adjusted all the way between T1 and and T plus3 the interesting piece will be the um will be the ETF Market where you have us ETFs that have a underlying basket of of Global Security um and so it's going to get a little bit tricky from probably the AP standpoint who are going out there and purchasing the underlying bated persons that's exactly right and uh uh with those individuals going out there and purchasing the underlying baskets and then having to subscribe it into the ETF so um that complication will have to be handled by them um and really making sure that those they align the the underlying basket with the the ETF us ETF at t+ one so yeah it's interesting talking about kind of the Securities Market I mean you know kind of from a from an exposure perspective Greg I think you've seen a really significant rally in the equity market and in some cases it's been quite narrow we we actually have a question up there just about the magnific of and the concentration around that um but kind of thinking about some of the things you're seeing and talking to clients about is that something they're concerned about are they thinking about like not only just in Awareness but like how ask you asking for Solutions and how can we hedge this narrow rally that we've been experiencing yeah so to address the question it's it's kind of a I always approach with clients it's a two-prong question a lot of clients are a lot of active management uh and a lot of active managers are very underweight Magnificent Seven stocks so their risk has been trying to keep up with this market and in those types of situation it's helping them just for our funds when we're managing it uh completion portfolios is maybe you want to bring that underweight just to a manageable level so that your tracking risk is not any greater than you can Toler so that's kind of on the on the active side Lot other clients if they're fully passive they've been enjoying this ride right they've been you really riding up on uh the Magnificent s strength and their concern is what if this thing rolls over and there's really you know a couple different ways we looked at from a MAG s in particular which is uh just a not necessarily options strategies at the stock level um but looking at uh Total return swaps that have uh equal weighted S&P rather than uh just long cap weighted S&P and that greatly reduces the exposure to Magnificent Seven so that's one solution that's been appealing not for the whole portfolio obviously but for a five or 10% sleeve or if they need to reallocate to equities thinking about doing it in that type of a framework rather than just the full s so that's that's one area and then kind of maybe expanding to the strength of the market overall and hedging strategies uh from the macro perspective uh there's really there's kind of two we've seen uh one in particular is just using the broad S&P Equity Hedges uh options uh to protect the downside or cut off the tail rist uh options pricing is predicated on applied volatility and uh you know higher volatility more expensive Hedges low volatility cheaper Hedges um and if you can bring up the volatility chart uh one of the things I think is interesting uh in the past few years markets is that um we've seen uh I think what feels like a volatile market right we've seen a lot of uh to and fro uh ups and downs but the last few years has really been driven by fixed income volatility and the uncertainty around interest rates and inflation and what's going to happen in the markets and as you can see on this chart this is Bond volatility in Gray and stock volatility in terms of bicks and the blue and that Divergence from what's really been a pretty steady historical pattern as they kind of rhyme and they Spike together uh the last two years has seen rates volatility Spike and Equity volatility has trended down to a very low level so you see actually this is not as current but like today this sitting about 13 which is historically very low kind of bottom desile type levels and so that dictates again options uh pricing and it's quite attractive for clients on a historic basis to take what is near all-time highs and protect some of those gains so that's definitely one area we've seen a lot of of interest and and structuring uh trades to protect there I mean maybe that's a good segue into kind of some of the underlying market dynamics that that you're seeing Le in like how you're hedging it and how you're that on your desk if we collaborate with Greg's team a great deal and that ml um that's the Merl Lynch um uh the mirl Lynch option volatility estimate index that was up on the screen before so again A A Benchmark in the in the fixed income rates as compared to the vix on the on the equity side so probably unsurprisingly you see that um that Gray Line moving quite a bit about in the last two years as Greg said just because I mean people have been surprised fed meeting to Fed meeting what's going to happen um and hoping for stabilization or even a cut and we've had that uh we've seen that in 20 2024 certainly and then on the equity side there have been uh a number of different um I mean that suppressed volatility has you know people have hypothesized has come from a number of different um segments of the marketplace one being um the um well two of them being certainly I don't mean to not necessarily causality but two factors in that that have been on the equity side dampening volatility are the um the ETFs that are call employee call overriding strategies which obviously have derivatives embedded in them um suppressing that um Equity ball and then we also have the zero uh days to xree um options that are um a relatively new product that have been gaining tremendous um tremendous popularity not just um and people may think it's it's retail but it's actually quite a bit of institutional use as well the so then people are like oh my goodness what about B mageddon and how how are these things going to going to play out and the shorter answer is probably not um the same as in 2018 with Armageddon because these are unlevered strategies so that's got that going for them however when something shifts and those um call overriding strategies are no longer participating in the market um that's when you may see that suppression of volatility essentially removed but maybe not in and but not in as dramatic event as we've seen in the past so have seen um we've seen a number of different inquiries as Greg and I again our teams have collaborated on very situational specific with what people are actually trying to hedge and what they're what they're worried about and with and with crash risk and how uh cheap because volatility is is um is is low this these types of strategies can be depending on what you're what you're looking at um have a thought there sorry I thought Greg was gonna jump in there um so that has been uh that has been really actually exciting to watch because I don't know that at Equity Market highs like this that we necessarily expected such low volatility to be paired with that uh so it's really been a rather interesting environment as the as the history of that P slide shows so we encourage and we've had I would say a lot of the conversations that we've had with clients have also been educational which has been very instructive because we learn more about what they care about and then we're also a able to to share our knowledge about what what is out there and what is and importantly what's Liquid enough for for a large Institutional Investor to employ primarily in the listed space I should say but occasionally in the bilateral OTC space Brandon what are you see in like the fixed income space it's either rates or credit I mean seeing some interesting challenges in there yeah I mean similarly drisking is kind of a major theme right now um we're seeing a lot of clients moving from from equities to fixed income um a lot of that move kind of seems to consist in in longer credit um or longer duration which could be you know supplemented by by treasury strips and stuff um again I think the volatility in the fixing space has been a lot and and predominantly in in the rate space and treasuries and stuff like that so um there is an immense amount of Supply in the market right now through new issuance and then some of the offloading of the balance sheet um that's going to kind of continue to create volatility over probably the next few months is everybody's kind of anticipating um you know what rates and stuff are going to do um some of the bigger things that are that are kind of you know to highlight over the last few years is that you know on theun Securities have have remained relatively tight due to the new issuance and stuff like that but you have this growing gap between on theun Securities and off theun Securities that these bit ass spreads and liquidity in the off theun treasuries have been not as as good as they have been in previous years and so as you get further off the run it's more and more difficult to buy into treasuries and stuff like that um there's a couple of new trading protocols that that are trying to help facilitate some of that there's an increased amount of flow that's going through the inter dealer market and uh that's probably uh due to a lot more larger blocks being traded in this particular Marketplace in the on theun secuity so you know you can utilize either a a time um volume weighted strategy in in inter dealer markets or you can effectively iceberg large position sizes to be able to minimize the market impact um and then there's this piece that is really kind of all the all trading that's going to be a really big component that comes into the treasury space it's been already in place in the credit space since 2015 um and really it's gonna kind of provide a little bit of depth um for stressful markets and I think what we saw in like March of 2020 surprisingly was the credit Market actually held up a little bit better than the treasury market did because of the reduction in capital from from broker dealers once that reduction in capital from broker dealers there was nobody else there in the treasury market to step in whereas in the corporate space a lot of the buy side firms became price makers and started supporting the market and and trading and it actually from a percentage standpoint it actually held up better than the treasury market so um yes talk about all all you mention that term what does that mean sorry all the all really kind of represents uh you have Street traders that can effectively trade as well as buy side firms so buy side firms can also bid into request for quotes or they can provide live pricing and stuff as well for through inventories um so all the all allows all Market participants all Market participants to interact anonymously in the market um and really kind of creates more liquidity and centralizes that liquidity to a single location um and so that again it kind of allows that dealers don't have to to be controlling that liquidity um and they can effectively if that Capital gets removed other firms hedge funds Insurance funds asset managers can provide prices provide bids and offers um and support the liquidity of of the marketplace so it's interesting we saw what you were saying with the February to March corporate uh 2020 it's like we saw historic uh volumes in the CDX space just record volumes coming through ahead of that um March Ro cycle yeah yeah and that's a big highlight of just kind of what Market how markets reacted in a really stressful unpredicted point in time um in the credit space yeah kind of moving into the credit space there's a couple of bigger pieces in electronic um again all the all continues to be a big component of this of of active Market participants on the buy side getting to capture more of that bit ass spread and I think a lot of that bigger push is Al ultimately um pushing individuals to do things or or have productss and tools in place such as electron Management Systems um execution Management Systems to be able to manage all these different protocols uh and when we're talking about having situations where you're trying to buy a large percentage in you know long credit and stuff like that you've got to be passive and opportunistic and these tools and electronic uh Management systems help you do that with all the different protocols and platforms that are available out there that's really really pretty interesting we actually have a couple questions from the audience that um Greg might actually ask you to oine on these I think they're they're similar in nature