An Interview with Michael O'Brien of Eaton Vance
Michael O'Brien, Global Head of Trading, Eaton Vance
As global head of trading at Eaton Vance, Michael O'Brien has a front row seat on the changes in financial markets over the past decade. His team of 12 traders, based in Singapore, London and Boston, are responsible for executing trades in interest rate, credit and foreign exchange markets around the world, including a wide range of listed and over-the-counter derivatives. In addition to executing trades on behalf of more than 100 Eaton Vance funds, O'Brien and his team are directly involved in the investment decision-making process for 15 Eaton Vance funds, including several absolute return funds that have a mandate to find investment opportunities in any asset class anywhere in the world.
O'Brien has been at Eaton Vance for 13 years, giving him a clear view on market conditions before and after the financial crisis. In this interview, he talks about the effects of the reforms put in place since the financial crisis in 2008. From his perspective as a trader, the main impact has been on the swap market, and in his view the results have been mixed. He sees the widespread adoption of clearing as a positive, and says his firm is now clearing nearly 100% of its interest rate and credit default swaps. On the other hand, he expresses disappointment at the lack of change in how swaps are executed. Despite the introduction of swap execution facilities, the process is still based on the traditional request-for-quote model,and he would welcome the opportunity to use a central limit order book for his swap trading.
On the horizon he sees more change coming, but more from the impact of technology than regulation. He predicts that artificial intelligence will transform the trade execution process more fundamentally than anything else he has seen in his career. He expects that machines will be able to analyze the quality of execution more accurately than ever before, and make trading decisions faster and more accurately than human traders.
MV: From your perspective as a buyside trader, what are the main effects of the financial reforms on the markets that you use and the way that you trade?
O'BRIEN: I break that down into two parts. First, there are some effects that have been positive. The clearing mandate is an example of that. We don’t just clear what we have to. We clear any product that we can clear because it has a lot of benefits, not just the counterparty risk reduction, but also other benefits that affect how we trade swaps.
The adoption of clearing was likely to happen over the long term anyway, but I think the clearing mandate really lit a re under the market to get it done sooner than it would have done. That has been very helpful to us in terms of the range of liquidity sources we can access, the ease with which we can get in and out of positions, and the elimination of a lot of documentation and legal work both pre-trade and post-trade. It has made the use of those derivatives more efficient and less costly. So clearing has been very successful, and it’s changed the way that we think about our use of derivatives.
On the trading mandate side, I think the regulations have not succeeded at what they were intended to accomplish. Trading OTC derivatives, the actual execution part, looks nearly identical today as it did the day before the swap execution facilities came into force. Historically, before SEFs, you would execute an OTC derivative by sending an RFQ to some banks via chat on your Bloomberg or on the phone. Today everything has gone electronic, and that's certainly more efficient, but nothing has really changed from a trading perspective. To me, that is a huge disappointment because I thought the trading mandate had a lot of potential to make some radical changes in the way derivatives are executed.
MV: We'll come back to that trading issue, but first let's talk about your use of clearing. How much clearing did you use before the crisis, before it was mandated? And how much clearing do you use today?
O'BRIEN: Before the crisis, we weren’t clearing any OTC derivatives. Obviously, we were clearing all the listed derivatives, but our first cleared OTC trade was in September 2012. Now it's somewhere around 70%, with interest rate swaps and credit default swaps being the main component of that. The FX market is the reason why our number isn’t 100%. That's because NDF [non-deliverable forward] clearing and forward clearing hasn’t taken off. There are FCMs [futures commission merchants] that will support it, but the execution does seem a little bit behind and it's hard to find people to trade with. If we could clear NDFs and deliverable forwards, that ratio would be very close to 100%.
MV: When you say the execution desks are a bit behind, what exactly is the hindrance?
O'BRIEN: There are roughly a dozen NDF pairs that are cleared in clearinghouses. We should be able to talk to a desk and say, hey, clear this for us. But the infrastructure isn’t built out as much on the dealer-to-client side as it is on the dealer-to-dealer side. My understanding is that most of the dealer-to-dealer trades in the NDF market are cleared. It’s just a matter of rolling that out to dealer-to-client trading.
I should clarify that we have cleared some NDFs, but it’s a very manual, cumbersome process for both us and the other side of the trade. Since it’s not scalable, at least not yet, we’re not doing it in large sizes.
MV: What about the costs of clearing such as margin requirements? How does that affect your use of clearing?
O'BRIEN: Certainly there are explicit costs of clearing, but I think they are outweighed by the implicit benefits, and that will become more obvious as mandatory initial margin on uncleared swaps comes into effect for asset managers. When an asset manager wants to unwind a bilateral swap, you have to go back to the original counterparty, or if you find a new counterparty, the two counterparties have to agree [on the unwind]. That is an operationally intensive process and it increases the number of people who know about your interest in trading. Clearing eliminates that. You are not constrained to a particular counterparty, and it limits information leakage on your trades. That has real benefits, especially in illiquid markets.
MV: Going back to the trading element of the reforms, do you think other buyside people feel the way that you do, that the impact of the trading regulations has been a disappointment?
"If we could clear NDFs and deliverable forwards, that ratio [of cleared to uncleared] would be very close to 100%."
Michael O'Brien
Eaton Vance
O'BRIEN: I don’t think anyone disputes my assertion that nothing has changed. My impression, though, is a lot of people don’t see anything wrong with that. Look, I've been a huge proponent of order books for OTC derivatives. I still am. If we can trade Treasury futures on an order book, I don’t see any reason why we can’t trade interest rate swaps on an order book. There are a lot of futures contracts that are a lot less liquid than interest rate swaps.
To be fair, the dealer-to-dealer market on SEFs does take the form of an order book. It’s the dealer-to-client CLOBs [central limit order books] that haven’t taken off, and that has a lot to do with the buyside demand for order books and issues with certain details such as name give-up. I’m not sure that I was right in the beginning about how much the buyside would want to trade on order books. I think I was a little of an outlier. I still think we will get there eventually, but we need to address some of the details that are preventing that from happening.
MV: Some buyside firms have said they prefer the current structure because it's better suited for large trades. If interest rate swaps moved to an order book, how would you get large trades done? Would there be enough liquidity?
O'BRIEN: My view on order books is not that we should move everything to the order book and get away from RFQ. The advantage of a central limit order book is that it offers anonymity and you can be a price maker or a price taker. There are some circumstances where RFQ makes more sense, such as when you need immediacy and you are willing to pay for that. If you need to make a trade right before an economic announcement, you might not have the time to work the order through a CLOB. But if you don't need immediacy, a skilled trader can get a better price through the order book. On top of that, there is far more liquidity in order books than people assume. Looking at the top of the book is not reflective of the size you can get done.
MV: The U.S. implemented most of the G-20 framework fairly quickly. Now that Europe has caught up with EMIR and MiFID II, do you see similar eects in European markets?
"One thing that makes me more positive is having these agreements on equivalence between the U.S. and Europe. If equivalence falls apart, then I would be a lot more concerned about the possibility of fragmentation and disruption in the markets."
Michael O'Brien
Eaton Vance
O'BRIEN: I think it’s too early to tell. The U.S. has implemented these changes, they’ve been in for a while, and we’ve observed what’s happening. A lot of the changes in Europe haven’t been around long enough to really make an observation.
One thing that makes me more positive is having these agreements on equivalence between the U.S. and Europe. Without equivalency, the potential for them to have a market impact would be larger. If equivalence falls apart, then I would be a lot more concerned about the possibility of fragmentation and disruption in the markets.
MV: To what degree has fragmentation already happened?
O'BRIEN: It is certainly happening, although its overall impact on us has been minimal so far. There are certainly products that trade on SEF and off SEF, as an example. We’re a U.S. person. I can access the SEF market, but not the off-SEF market. So that’s one area where there is fragmentation that impacts me.
MV: One of the other big forces affecting these markets is the change in the technology of trading. How are technologies such as artificial intelligence affecting how you trade?
O'BRIEN: I think this is going to be one of the biggest themes for buyside trading desks moving forward. We have seen a lot of changes in technology, such as the electronification of markets that were formerly on the phone. But those haven't really been that revolutionary. The electronification of trading took an existing process—picking up a phone and calling a counterparty—and made it more efficient. That certainly was important in that it has allowed us to compare prices faster and made the post-trade process much more effcient. But it's not that revolutionary.
As we look forward, I think that's going to change. The technologies that are assisting our ability to execute, in terms of more intelligent execution and the collection and analysis of data, are going to have a huge impact on the way trades are executed and the measurement of the quality of trade execution. The TCA [transaction cost analysis] industry is growing rapidly. They have a lot of data problems, but we’re at a point now where we are seeing more solutions than ever before. That is going to be one of my big focuses moving forward—how I can use this technology to improve the quality of our execution and demonstrate that in a quantitative way.
MV: Are you in an exploratory phase, or are you actually starting to use these tools on your trading desk?
O'BRIEN: I would describe it as more exploratory at the moment. The challenge is there’s going to be far more technology that comes to market than we have the budget for and the resources to pursue. One of the ways I think companies like ours will differentiate themselves is by the decisions they make on what technology to employ. Because there’s a huge amount of it out there. It’s a little bit like the execution platforms in FX and the Treasury market and even the futures market. There’s just too much of it to use it all. Those choices will become more and more important.
