No bank has done more to develop its market-making capability in credit derivatives than Deutsche Bank. It wins thanks to its determined push in this fast-growing business

This award has been given to the bank that has made the biggest strides in developing the size and breadth of its own customer business, and in exploiting relative value arbitrage opportunities in the global credit market.

In short, market-making, which remains at the heart of credit derivatives activity. Deutsche Bank has been more concerned with this function than with laying off its own risk.

Deutsche has made a major push in credit derivatives, adding staff and building up its market-making capabilities. It has concentrated on building a customer-driven business for credit derivatives, rather than being an end-user for the purposes of loan portfolio management.

Furthermore, Deutsche has developed a global business in products ranging from plain-vanilla credit default swaps to more exotic structures such as stripped convertibles; and it has demonstrated a willingness to risk capital, with which the global credit derivatives division has achieved the highest return on capital within Deutsche’s capital markets group.

Ron Tanemura, global head of credit derivatives at Deutsche Bank, says: “Credit derivatives allow clients to get what they want. A simple example is how a name in yen may trade at a very different price to the exact same name in Deutschmarks. There is no credit reason for this, but there may be others, perhaps as simple as differences of opinion between Japanese and German investors for that particular issuer. Through asset swaps, credit swaps, repackaging or credit-linked notes (CLNs) we can capture that difference in price and deliver value to the client who has the stronger demand for that name.”

Many banks are using credit derivatives to take assets of the balance sheet. A number are also using them to structure synthetic collateralised loan obligations (CLO) or collateralised bond obligations (CBO).

JP Morgan was a strong contender, with other banks including Dresdner, Credit Suisse First Boston and Morgan Stanley Dean Witter all active in the market over the past year. JP Morgan has transformed its balance sheet using these instruments, employing around $40 billion of credit derivatives to help cut the economic capital in its credit portfolios by half. It has saved itself some $600 million in capital reserves for credit losses by doing so.

While JP Morgan undoubtedly remains the market leader in synthetic CLO-type transactions, Deutsche also became active in this area during 1999. It launched the $5 billion Blue Stripe CLO in July and the €2.9 billion CAST 1999–1 deal in November (Risk, December 1999). But Ron Tanemura insists this is not its core business. “CAST was a great transaction for us, allowing Deutsche Bank to break new ground in loan portfolio management, but I think the role of synthetic CLOs in the world of credit derivatives is a little overstated,” he says.

“Synthetic CLOs are large, chunky, public market trades so they get a lot of attention, but really the breadth of applications of the risk-transfer/risk-transformation power of credit derivatives is much greater. If you want to provide value to your clients, what counts is market-making capability, willingness to risk capital, breadth of names traded, breadth of products traded, structuring skills – the same things that add value in other fixed-income businesses.”

With 30 credit derivatives traders in Europe, and 15 each in the US and Asia, Deutsche’s presence in credit derivatives rose sharply in 1999. The volumes it has handled on single-name credit default swaps, for example, are mainly from its trading activities rather than sourced from swaps bought to cover its own loan book. Despite this focus on building up a trading desk, Tanemura predicts Deutsche will also step up its activities as an end-user of these products. “One of our goals this year, and next year, is to develop Deutsche Bank further as an end-user for loan portfolio management,” he says.

As well as a global presence in the core market for single-name credit default swaps – where it trades high-yield, investment-grade and emerging market names – Deutsche has also been active in instruments such as stripped convertible bonds, where the credit and equity components of a convertible bond are separated and sold separately.

“The pool of demand for convertible bonds is really smaller than some would think,” says Tanemura. “As a single asset they typically go to specialist funds. But by separating the credit component from the equity component we are able to broaden the audience for this asset dramatically.” Deutsche conducted more than 350 stripped convertible transactions in 1999.

Other credit instruments where the bank has built a significant presence include index swaps and medium-term notes. Tanemura describes his desk as “the number-one private placement team” for MTNs, with more than 700 structured transactions completed last year.

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