The rate of change

Alistair Mullen explains how the rates business has been central to the crisis and to the recovery

What does your role involve exactly?

My job is effectively head of flow interest rate sales. The fixed income division at a bank is run across three asset lines: foreign exchange markets, rates and credit. Most people are familiar with the concept of FX and credit. But people can find rates a little bit difficult to understand. What are you trading when you're trading an interest rate? What is an interest rate? It's pretty easy to explain what an equity is, people know that. It's pretty easy to explain what FX is, before you go into the various technical products that can get very complex. With rates, you're trading, buying and selling to clients the price at which interest rates are set. When we say "we sell interest rates", what we mean is we talk to institutional investors about putting on transactions that will make or lose money depending on the movements of global interest rates. You might talk about government rates - in the UK that means the base rate set by the Bank of England. But it could be any government issuing debt, or trading derivatives of that debt. Or you can go out to where the market dictates interest rates. You might still be talking about trading the same instruments: bonds and derivatives, but it's assumed there's a greater risk of defaulting. That's reflected in the pricing, the market rate is discounted against the risk-free government rate.

What services do you offer clients?

It's easier if you talk about a particular type of client. Let's take a hedge fund as an example. We can put a price on any transaction they want to make. That's called execution and is a significant part of the business. So we can execute a transaction for them, which could just mean responding to a telephone call, an email or a Bloomberg message: "can you price this?" Most of the product we trade is priced within 2 or 3 minutes.

The client will always have a view on a transaction. The reason why they're trading is because the market pricing and their view are not consistent. The market has a price for every interest rate at every point in time, it's continuous. If you have a strong view, and that view isn't echoed by the market, there's a potential trading opportunity. If your view is the same as the market's then theoretically that should be priced in and there's not really a transaction there.

The clients can trade one of two or three things. The first one is direction. For example, are the rates going up or down? It's the equivalent of looking at whether or not the FTSE is going to rise or fall. The second type of transaction is on a relative value basis. For this you need to understand the concept of a yield curve. Let's take the example of the UK gilt market. The government will sell a whole series of gilts, from bills in a very short date (60 or 90 days) right up to 30 or possibly 50 year maturities. The yield on a bond is the return on the investment. You can plot a simple graph of yield against time. It produces a yield curve. It's generally upwards sloping: the longer you want to borrow money for the more you have to pay. That's orthodox economic theory and it makes sense in the majority of occasions. So for this type of transaction you ask "where are rates currently?" Let's say they're very low in the short end. You have to decide whether or not the short are rates likely to rise quickly. This would affect the shape of the yield curve (it would flatten) and the price of the trade. The third type of transaction would be a cross market trade. This would be the equivalent in the equities market of comparing sectors: technologies versus industrials or something like that. We could trade the US market versus the UK market or, intra-EU, France versus Spain etc. So selling interest rates is a very simple term, but the number of strategies within that sphere is infinite.

And in all of these types of transactions you're trying to beat the price of the market rate?

In theory that's what you're trying to do. Using analysis you decide the market's either missed something or thought too much of it. The whole concept of efficient markets has been challenged in the past few years. Even if everyone had the same information, people could still trade because they would take different views on what a certain thing might do. That's why there's lots of dialogue involved in lots of these transactions and trade ideas.

So, with a direction trade, for example, would you actually advise the clients on which way you think it's going?

Advising is a difficult and dangerous word. In many ways we don't give advice in the literal sense, due to compliance and FSA regulation. You're interacting with clients outlining what your thoughts are, where your firm has position, where you have risk capital, what the economics and strategy views are of the house. So the client should have thoughts on the house view and then you can have an informed conversation.

What do you enjoy about this work?

The key with interest rates is that it's a very macro phenomenon. You only have to look at the last two years. If you were to blame one particular product or area for the crisis you'd be looking at the credit business and the CDO [collaterised debt obligation] business. That's an over-exaggeration but it's the best thing to point the finger at. But equally, if you look at the recovery, at what people have been trading to get out of the crisis or using to judge how far through it we are, the answer is rates product. The rates business has been the benchmark product for this whole crisis. Extraordinary monetary measures have been based around reactions in the fixed income rates market. If you don't find that interesting then you're probably in the wrong job.

What would you say to graduates thinking of going into banking who are slightly put off by what's happened in the last two years, or by some of the negative media stories we're still getting at the moment surrounding bonuses etc?

I personally think there's no more interesting a time to go into banking. Is banking here to stay? It's been around for thousands of years and it's not going away. Every ten to fifteen years there's a crisis and it reinvents itself. For me, the biggest challenge out there in the world is the green challenge. Banking will focus on looking at financing the projects. It's not about making money, it's about saving the planet. So a small resource allocation away from banking towards greener industries is obviously something positive. Banking must be involved in financing green projects. BNP Paribas has itself has been involved in many areas: project finance for renewable energy in Spain, big windmill farms etc. We have a carbon trading desk that was set up about a year ago. These are all areas that will employ people. It's a great time to join banking if you want to be a part of that challenge. 

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