The Proprietary Shuffle

How will the dreaded Volcker rule really effect the proprietary trading of banks on The Street? For going on two years now, we've heard nothing but how irresponsible traders have landed America in a pool of sludge along with the wee baby turtles.

"These swashbuckling financial pirates in tailor-made suits, swinging from vines with swords clenched firmly in tooth, avoiding the long arm of the law and robbing the innocent investor, must be stopped!!!", was the rhetoric of the day.

News coming out of several large banks, including Morgan and Citi , shows financial firms taking a pro-active stance which may take a large chunk out of the expected government bite.

One of the favorite tactics seems to be moving traders to different desks from which they can bypass the specific legal language of the new laws. Check out the "Shuffling the Decks" section in the article for a quick synopsis of what the big boys are doing about the situation.

Three questions:

1) Will customer fears of getting their trading strategies, hi-jacked by traders at these new desks (where they have direct access to customer ideas/strategies)lead to monetary pull-out of the banks' accounts?

2) Will the SEC ever begin to adopt a more CFTC-like approach to regulation? In other words, using common sense instead of rigid legal processes which amount to little more than nothing?

3) Will this really change "business as usual" in bank proprietary trading Street and World wide?

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Jul 6, 2010 - 12:39pm
Midas Mulligan Magoo, what's your opinion? Comment below:

My apologies about the link. Here's full article:


Some Wall Street firms aren't waiting until the Volcker rule kicks in to shake up the trading desks that wager the banks' own money.

As the financial-regulation overhaul heads toward a final vote in the Senate next week, banks are scrambling to find new positions for star proprietary traders, who basically trade company money in hopes of fattening bank profits and their own paychecks but could become an endangered species once the rule takes effect.

Citigroup Inc. is considering moving roughly two dozen proprietary traders onto desks that trade with company clients, according to people familiar with the situation. Other firms already have shifted proprietary traders to customer-focused trading operations.

The moves don't necessarily mean that the days of wagering with a bank's capital are numbered. Many expect an increase in risk-taking in trading operations that cater to clients as traders build an inventory of stocks and bonds to meet demand from hedge funds, money managers and other customers.

At Morgan Stanley, one proprietary trader whose desk was shut down after the financial crisis now trades using capital from a trading desk that serves stock-trading clients, said a person familiar with the matter. Another Morgan Stanley proprietary trader who left for Deutsche Bank AG also essentially bets with the German bank's capital on a trading desk for clients, this person added.

In Hong Kong, a small group of Morgan Stanley proprietary traders who buy and sell securities using the firm's capital started using "corporate derivatives" to describe their role earlier this year, according to a person familiar with the matter.

Normally, that term would describe traders focused primarily on helping big bank clients, including corporations, buy and sell derivatives in an attempt to hedge, or limit, losses from exposure to certain commodities or other markets, people familiar with the matter say.

"Certainly, there will be opportunities to put some of these professionals to work doing what they do best in other parts of the firm," says Joseph Vitale, a partner in the bank-regulatory practice at law firm Schulte Roth & Zabel LLP. "The question is to what extent will they be trading with the house's money versus client money?"

It isn't clear if regulators will see the shifts as anything more than sleight of hand. The Volcker rule, named for Obama Administration adviser and former Federal Reserve Chief Paul Volcker and passed by the House last week as part of the financial-overhaul bill, directs federal officials to disallow most proprietary trading at banks unless the trades are meant to serve near-term client demand or reduce risk.

But does that mean a trader can't buy a bunch of bonds in anticipation that investors would want to buy them a week later at a higher price? What if the trader holds the bonds for a month or two? Such scenarios make it difficult to draw a clear line between proprietary trading and the sort of client-centered trades typically handled by separate desks at most firms. Regulators could take years to establish clear rules. They expect Wall Street firms to push for more risk-taking as they test the limits of new rules, say people familiar with the matter.

Not surprisingly, many Wall Street clients are leery about proprietary traders moving to desks where the traders could see the investment strategies of a firm's customers. One worry is that traders will snatch customer ideas for themselves, pushing prices against clients before their buy and sell orders are completed by the firm.

"Aggressive people will go right up to the line. Conservative people won't. That's the game," said Ernie Patrikis, a partner in the banking-advisory practice at law firm White & Case LLP and a former general counsel for the Federal Reserve Bank of New York.

Proprietary trading has always been controversial, but scrutiny of the business surged after several firms suffered massive trading losses during the financial crisis. As a result, Wall Street has been retreating from the so-called "pure" proprietary-trading desks that regularly churned out billion-dollar profits just a few years ago.

"Most firms have significantly downsized this business," Citigroup analyst Keith Horowitz wrote in a research note. Still, Goldman Sachs Group Inc. and Morgan Stanley still have sizable trading desks that "must be ceased or divested" under the Volcker rule, the analyst wrote.

Goldman has two large proprietary-trading desks, one run out of the New York company's giant fixed-income unit called Special Situations Group. The second desk, Goldman Sachs Principal Strategies, is part of the equities division. In the past, some traders who left those desks stayed at Goldman to manage hedge funds, while others left the firm.

Shuffling the Decks: How Banks Redefine 'Prop' Traders

Goldman Sachs Group

The New York company has two large proprietary-trading desks. The desk in the firm's fixedincome unit generated earnings of about $4 billion in 2006, the year that Mark McGoldrick, who ran the desk, was paid $70 million. He then left to start his own hedge fund.

Together with the proprietary-trading desk run by the equities business, the two desks manage about $9 billion, estimates Citigroup analyst Keith Horowitz. Getting rid of them could cost the firm about 4% of its trading revenue. Goldman has said the firm's proprietary trading and investing add up to about 10% of overall revenue.

One Goldman partner recently rival that the firm felt it "lost the battle" in Congress but hopes to win the next round-a reference to when regulators decide how the proprietary-trading curbs will work, a person familiar with the matter said.

Morgan Stanley

After posting a $9 billion mortgage-trading loss on a proprietary desk in 2007, Morgan Stanley closed two fixed-income proprietary trading desks. The largest remaining desk, a statistical arbitrage-trading desk, generates about of 2% of the firm's revenue.

Many traders who took proprietary positions at the firm have left or been reassigned to jobs that serve clients.

Bank of America

The Charlotte, N.C., bank has a team of about 60 people, funded with about $3 billion in capital, that trades a proprietary account for the bank, according to people familiar with the situation. The business came with the acquisition of Merrill Lynch Co.

J.P. Morgan Chase

Morgan downsized its proprietary-trading and investing businesses in 2008 and 2009, shifting an executive, Bob Case, into a risk-management job in a separate division of the New York company.

Another executive involved with proprietary trading, Patrik Edsparr, left for Citadel, the Chicago hedgefund operator. Proprietary desks now are scattered within J.P. Morgan divisions.


The company lost about 10 traders to hedge-fund operators such as Moore Capital and SAC Capital Advisors after the Volcker rule was unveiled in January. Citigroup still has several proprietary-trading desks with about five different strategies.

Citigroup Chief Executive Vikram Pandit has said that banks shouldn't be "speculating with their own capital." The company's remaining proprietary traders might be transferred to customer trading desks where they still could make bets using Citigroup's capital, according to people familiar with the situation.

Deutsche Bank and Credit Suisse Group

The two European firms have pared proprietary trading, and are expected to be able to keep some of what they have left as long as it remains based outside the U.S. Some analysts expect them to move more traders outside the U.S. Under the currency version of the legislation, U.S. banks would have a harder time moving their prop trading overseas because the parent firms are organized under U.S. bank laws.

Like most banks aside from Goldman, prop trading desks account for a small percentage of earnings, although they were larger before the global financial crisis. At Credit Suisse, the proprietary-trading business was scaled back by as much as 75% in 2008. The Swiss bank's remaining prop-trading business is tied to heavily traded securities.

Jul 6, 2010 - 3:32pm
ambition56, what's your opinion? Comment below:

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