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From BloombergView Columnist Matt Levine:

I guess the new normal in banking is that every time a trading desk makes a little money, it's going to be news, and they'll get an article congratulating them for it. It's like when the employee lottery pool at the toy factory wins the Powerball, and there's a little profile about them in the local paper. Except it's interest-rate swap trading or whatever:

A team of Citigroup Inc. derivatives traders generated about $300 million of revenue this year, thriving from serving companies and investors trying to anticipate central bank decisions, according to people with direct knowledge of the matter.

 

The windfall was produced by the bank’s U.S. dollar interest-rate swaps desk led by Geoff Weber in New York, according to the people, who asked not to be identified because the firm doesn’t break out results for such businesses. The group includes Dan Leadbetter, Daniel Gottlander and Mark Zaguskin, one person said.

These profiles are not pure jolly human-interest stories, though, because they are tinged with a bit of doubt about the Volcker Rule. Is this prop trading? How can a bank make $300 million in trading if it's not "prop"? And the answer is always sort of obvious, though not universally satisfying. Clients want to do interest-rate swaps. There's a lot of demand. Swaps aren't quite like stocks; you don't buy 100 swaps from a customer one second and sell them to another customer the next. They are principal trades, often with terms of many years; you enter into a swap and then you just ... have it. You hedge it -- perhaps by entering partially or entirely offsetting swaps with other counterparties, or by trading Treasuries or interest-rate futures or -- but you will likely be left with some residual risk, and that risk could be profitable. (Or: risky.) Also of course you just charge clients for the market-making service, and if you do a lot of trades you'll make a lot of money just on bid/ask spreads. And Citi has seen a lot of customer demand, so it's done a lot of trades:

Weber’s team also has been minting revenue tied to the bank’s handling of corporate bond deals by working with clients issuing the debt, according to the people. In such cases, companies typically sell debt to investors with a fixed interest rate, then enter a contract with the bank to pay a variable rate.

The last time we did this -- when Goldman trader Tom Malafronte was reported to have made $100 million trading high-yield bonds -- I said that just buying some bonds and making money when their price went up wasn't in itself prop trading. It depends how you came by those bonds. "If you go out looking for bonds to buy, that is prop," I said. "If the bonds come to you, that is market making."

But that was oversimplified, and you can see one reason why in the interest-rate swaps case. Clients didn't just wander into Citigroup's lobby looking to buy swaps. Citi's industry coverage bankers built relationships with those corporate issuers, and its corporate bankers loaned them money, and its mergers-and-acquisitions bankers convinced them to do acquisitions, and its debt capital markets bankers convinced them to sell bonds to fund those acquisitions, and its derivatives salespeople tagged along to those meetings to convince them to swap those bonds to floating. And then, after all that effort, the client entered into a big swap trade with Citi on the other side, taking the risk for its own account. That's how derivative dealing works: You think up a trade you'd like to do, you go out and convince a customer to do that trade, and then you take the risk on the other side of the trade. (And, normally, hedge.) The essential reason that it is permitted "market making" rather than forbidden "proprietary trading" is that a customer wanted to do the trade -- but there is no rule against the bank working really hard to convince the customer that that's what it wants.