September 15, 2011 3:14 pm

‘Delta One’ forced out of the shadows

Not since Jérôme Kerviel’s €4.9bn loss at Société Générale has ‘Delta One’ – a little-known but fast-growing part of the investment banking business – known such prominence.

Now Kweku Adoboli, the trader accused of causing a $2bn loss at UBS, has cast an unwelcome spotlight once again on this shadowy corner of the banking world in which Mr Kerviel caused mayhem in 2008. Mr Adoboli lists “Delta1” in his professional profile on LinkedIn.


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In simple terms, the Delta One business involves banks trading securities that track an underlying asset, such as shares or silver, as closely as possible, which means it is often associated with exchange traded funds (ETFs) and swaps.

ETFs are collateralised equity securities designed to track indices, while swaps are a kind of derivative security issued by banks which offer clients exposure to indices, bespoke baskets of securities or other instruments.

In some cases, banks are known to deploy high-frequency trading technology and algorithms to make money from tiny deviations in product and asset values.

Delta One desks at banks can cover a range of asset classes – everything from currencies to equities and commodities. Mr Kerviel was involved in stock index futures, for instance, exploiting discrepancies between equity derivatives and the underlying cash prices. It is not yet known what assets Mr Adoboli was trading.

In practice, the business sits in a unique position between trading for clients and so-called proprietary trading – or trading for a bank’s own account. Some have even described the business as “flow-prop,” referring to ‘flow’ from clients and proprietary trading. That’s because while Delta One practitioners may be committed to tracking the underlying assets as closely as possible for their clients, they retain a degree of flexibility in how that’s achieved.

“Delta One desks are frequently used by hedge funds to hedge their portfolios,” said Sal Arnuk, at Themis Trading. “So, for example, if the hedge fund owns $1.2bn worth of US equities in a specific list of 25 stocks, and they want to hedge against an adverse 15 per cent move in that portfolio, they may call upon a Delta One desk at a major bank to help them create that hedge.”

Any excess profit generated by using assets associated with the products can be kept by the bank – meaning money is made as much from taking a view by creating innovative hedges as it is from collecting margins and fees from clients. Of course, while banks can skim off excess profits when trades go well, if the hedging strategy goes wrong, they could be exposed to losses.

The details of Mr Adoboli’s trade remain unknown.

“It could be anything, it could be hedges,” said an industry source. “At this level of losses, it’s impossible to be related to ETFs. The sums amassed are far too big. The ETF business is a marginal business. It’s very hard to make some money on these low-margin products.”

Nonetheless, the $2bn is likely to cast an unflattering light over Delta One operations, which are thought to be one of the fastest growing businesses for investment banks despite still being relatively unknown.

“They are secretive because their ‘edge’ is to a large extent based on their proprietary technology, algorithms and related hedging strategies,” said another source. “If competitors are able to replicate this it will erode their ability to make money.”

JPMorgan for instance, last year predicted that Delta One would be a prime source of revenue growth for the world’s investment banks. “Most players have high ambitions in Delta One products, ETF[s] in particular, where volumes are expected to grow further by 20 per cent per annum” JPMorgan’s Kian Abouhossein wrote at the time.

The US bank said in its report that Société Générale, BNP Paribas, and Goldman Sachs were the largest Delta One players in Europe. In the US, meanwhile, Goldman Sachs and Morgan Stanley were thought by JPMorgan to be the biggest.

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