The final version of the Volcker rule appears to be tougher on proprietary trading â€“ or bank trading on behalf of the banks â€“ than when it was first proposed two years ago, despite industry hopes for greater leeway.
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The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
America’s financial watchdogs have made a rod for their own backs out of the Volcker Rule. The final draft of the legislation, passed by five banking regulators on Tuesday [Dec. 10], bans the nation’s banks from outright prop trading and from London Whale-style hedging. But the onus is on regulators to prove if banks step over the line.
To be fair, Congress handed financial policymakers a Herculean task. The 2010 Dodd-Frank Act mandated a clear distinction be drawn between client activities like making markets in securities, underwriting stock and bond sales and hedging on the one hand and trading for an institution’s own benefit on the other. After three years of back and forth, regulators have not done too badly, balancing the spirit of reform with the need not to be too overbearing.
They have not, for example, imposed strict limits on either the type or the size of trades banks can undertake with their own capital for the benefit of their clients. Instead, banks will have to rely on their own metrics, such as what they have done in the past, to justify what passes through their books.
That’s where it gets tricky for the trader police. First, it leaves them in a purely reactionary mode. Second, regulators will have to pore over reams of data just to find a position that looks out of whack and then dig even deeper to work out if it breaks the law. And they’ll yet again be relying on data provided to them by banks.
The Volcker Rule doesn’t remove all prop trading, either. U.S. Treasuries are still fair game, as are foreign government bonds, in some circumstances. That’s a pretty large exception to the ban: all in, the rates business to which these markets belong makes up as much as 70 percent of the industry’s fixed-income trading revenue, Morgan Stanley President Colm Kelleher told investors on Tuesday before the final rule was published.
Wall Street is unlikely to be jumping for joy, though. The rule still crimps their trading, leaves much open to interpretation, adds to compliance costs and puts chief executives on the hook for any failure. They should spare a thought for their overseers, though, who now have to find a way to marshal a 1,000-page beast of their own making.
Reuters’ Washington News Editor Karey Wutkowski breaks down what’s in the final version of the Volcker rule, which bans banks from taking big risks with their money. The may be more strict than originally thought. Later, FBR Fund Advisors Inc. bank analyst Paul Miller and Reuters Breakingviews’ Antony Currie discuss what the rule means for banks.
Speaking to a gathering of the PEW Charitable Trusts, Treasury Secretary Jack Lew made the case for completing the Dodd-Frank financial regulatory reform agenda, including passing the Volcker rule, which would ban bank proprietary trading. Lew said the Volcker rule would prohibit the kind of trading that JPMorgan engaged in that cost it $6 billion in losses.
(The authors are Reuters Breakingviews columnists. The views expressed are their own.)
America’s watchdogs look set to adopt a version of the Volcker Rule that’s too complex to be practical. Next week at least four of the nation’s five regulators involved in the process are likely to adopt a stricter draft of the law banning proprietary trading than expected, according to Reuters. That may impede banks’ ability to hedge risk and trade for clients.
Banning outright prop trading is pretty simple. Former Federal Reserve Chairman Paul Volcker, who inspired the rule, was right when he said prop trading was like porn â€“ you know it when you see it. That was clear to Wall Street, too, as most firms quickly got out of that part of the business.
The problem in writing the rule, passed by Congress in the 2010 Dodd-Frank Act, comes from elsewhere. First, there’s the question of how to treat trades executed for clients where banks use their own capital. These can get risky and can also provide opportunities for less scrupulous traders to try to make a fast buck on the side.
Second, JPMorgan’s $6 billion loss on the so-called London Whale trade last year raised the question of when a hedge is really a hedge.
It sounds like the regulators have opted to take a tough line. For example, the rule may only allow banks to hedge very specific risks. That should satisfy bank critics. But such proscriptive rules could make it difficult for banks to make markets in securities. That would reduce liquidity, making it harder for investors to buy and sell and potentially increasing companies’ cost for raising capital.
A better approach would be to have a more general rule and then set up an early warning system to send a red flag to regulators if and when a bank’s trading business crosses the line. This could be done using a metric such as the Sharpe ratio, which assesses risk-adjusted returns. A higher ratio suggests less volatility and thus more of a market-making business, while a lower ratio suggests prop trading.
Regulators could then pounce, check the bank’s trading records and, where necessary, prohibit them from certain trading activities and levy a fine.
It’s not a perfect solution either. But compared to an outright ban in a rule that so far covers 1,000 pages that may upend markets, it looks far smarter and realistic.
The fastest growing segment of the financial services industry was the one hardest hit by MF Global’s suspicious demise and overt fraud at Peregrine Financial Group (PFG).
The managed futures industry, which had grown from $14 billion under management in 1991 to over $329 billion to end 2012, was a shining star of the new economy. Offering the unique ability to zig when other investments zagged, the lack of correlation and performance during crisis were key points of attraction. This attraction came to a screeching halt with the MF Global and PFG criminal incidents. Not only were investors getting acquainted with the asset class shocked to learn their accounts were looted of assets, but more troubling criminal behavior appeared the cause - casting a shadow over all participants.
“There is a severe loss of trust, a loss of confidence. There is incredible anger and frustration. Things need to change,” said Diane Mix Birnberg, president of Horizon Cash Management. Her firm just released a study, The Aftermath of MF Global and Peregrine Financial Group Meltdowns: A Crisis of Trust, showing that a whopping 91% of respondents believed there was a breakdown in audit procedures.
The study themes that emerged included:
- The laws and rules that govern the industry need to have ‘teeth’ â€“ and those involved in fraud and theft need to be punished.
- Customer segregated funds must either be kept completely out of the FCM and/or be verified in real-time by regulators.
A strong and rare female voice inside a Type A male dominated industry, Ms Birnberg’s firm, Horizon Cash Management, has become the top cash management firm for participants in the managed futures industry. Starting in the 1970s as a secretary in a stock brokerage firm in Atlanta, where “women generally didn’t think about career aspirations,” she later joined Lehman Brothers in the bond business. After moving to New York City to work on Wall Street, she was recruited in 1980 by investors to operate a cash management firm in the futures industry and in 1991 founded Horizon Cash Management, which currently has $2 billion under management.
In MF Global “there was very little institutional leadership (from exchanges, regulators and major firms),” she said. “This resulted in rumor, innuendo and ultimately a lack of trust. The void in leadership is terrifying.”
Looking back on the MF Global and PFG disasters, Ms. Birnberg has the experience of witnessing 10 FCM implosions. “In every FCM implosion it has negatively touched the CTA / CPO segment of the industry.”
“Think about a plane crash,” she said. “When it happens? Key issues and facts are addressed by the airline, the FAA and even the US president. Information is available regarding what happened, why it happened and steps being taken to address the problem.”
With MF Global a plane crashed and there was silence.
This is the first part of a two part article.
Mark Melin is author of three books and taught a managed futures course for Northwestern University’s Executive Education program. To read additional blog posts visit www.UncorrelatedInvestments.com (requires free registration).
The voluntary return of $546 million in MF Global customer assets, the subject of hard fought 2 Â˝ year battle, was not motivated solely by the kindness of JP Morgan.Â Rather, it could be considered fruit from a likely hard investigation now gearing up if not already under way.Â This investigation, declared “dead” many times over in leaks to the press from official sources, has heated up, asÂ first discussed here.
The return of illegally transferred MF Global customerÂ assetsÂ was always a key bone of contention.Â JP Morgan had summarily dismissed regulatory and public pressure to return customer assets, so the question is: why submit to authority now?
In 2012 the National Futures Association (NFA) went so far as to send the bank a public letter, which was generally brushed aside as were numerous verbal requests and mounting public pressure from groups such as the Commodity Customer Collation and its leaders James Koutoulas and John Roe.Â This significant pressure was dismissed, yet an attempt by bankruptcy trustee James Giddens was successful. Â The fact this occurred at this moment in time is not aÂ coincidence.
Speculation is JP Morganâ€™s normally dismissive attitude towards government regulators might have changed in the face of what is expected to be a no holds bar CFTC / DoJ criminal investigation.Â In other words, the specter of government actually asserting itself and allowing career investigators to do their jobs unimpeded is enough motivation for JP Morgan to return what are documented to be illegally transferred customer assets.
But perhaps more important to the future, a real investigation could also be motivation for JP Morgan to provide critical testimony regarding the criminal activity of MF Global executives, including that of Jon Corzine.
The need for deterrence that derives from a Jon Corzine conviction is more important because the future that matters most.Â Since 2008, when financial crimes that damaged the US financial system were was documented not to be investigated by DoJâ€™s former assistant attorney general in charge of criminal investigations Lanny Breuer, Wall Street crime has imploded in its brazen disregard.Â MF Global is one example, but the case of HSBC laundering money for terrorist organizations and drug cartels â€“ after being warned on several occasions not to do so â€“ is a sign of complete disrespect and a breakdown of law and order on Wall Street. Â Â When the full story is known, Mr. Corzineâ€™s disrespect for the US financial system and its cogs of justice will likely stand as the turning point in a long battle.
Is this real?Â Is the investigation a serious point where the rule of law might actually apply to once exempt Wall Street players?Â We donâ€™t know for certain at this point, but one key tell is going to be the type of charges filed against MF Global executives.Â If RICO charges are used, this will send the powerful message that a cop is in fact back on the beat.
Mark Melin is author of three books and taught a course on managed futures for Northwestern University’s Executive Education program. Â To read more of his blog posts, click here (requires free registration). Â Contents Copyright (C) 2013 Mark Melin.
NEW YORK (Reuters)â€”Morgan Stanley plans to slash 1,600 jobs in what may be just the beginning of a new round of layoffs at large investment banks, this time driven by a deeper reassessment of Wall Street businesses in the face of new regulations and capital standards.
Morgan Stanley, the sixth largest U.S. bank by assets, plans to begin letting go of the employees, many of whom work in its securities unit, starting this week, two people familiar with the matter said on Wednesday [Jan. 9].
A third person who has been involved with plans to cut staff at Morgan Stanley and other large banks said that Morgan Stanley’s cuts had been in the works for months, and that more are expected in the future.
Large global investment banks have been cutting staff for the better part of five years, when the financial crisis pegged to the U.S. housing market began to seize up markets. Firms previously focused their job cuts on areas where activity had screeched to a halt, such as securitization of mortgages, or that were explicitly banned by new regulations, such as proprietary trading.
But banks are now making strategic decisions about businesses in grey areas where management teams do not see major profit potential, or realize that their individual banks are not competitive, the third source said.
“It’s hard to look at yourself in the mirror, and say: ‘I’m not good at this,’” said the source. But now that management teams are coming to those realizations, he said, they are beginning to make strategic decisions to exit businesses and cut more staff.
So far, the most prominent example of a bank making that kind of a tough decision is Swiss bank UBS AG, which said in October that it would exit bond trading altogether and eliminate 10,000 jobs.
Morgan Stanley has said it will not give up on the fixed income, currency and commodities trading business, known as “FICC” in Wall Street circles. The firm has said it wants to boost market share in FICC by two percentage points.
But Morgan Stanley is aiming to exit more complex realms of bond trading that require more capital under new regulations. The latest staff reductions will affect 6 percent of the institutional securities unit’s workforce, which includes the bank’s FICC business. The cuts will target salespeople, traders and investment bankers, the sources said. Support staff who work in areas such as technology will also be affected, the sources said.
Although all staff levels will be affected, the likely targets will be more senior employees who take in the biggest paychecks, and about half of the cuts will come from the United States, one of the sources said.
The cuts are also notable because, unlike its chief rival Goldman Sachs Group Inc., which culls the bottom 5 percent of its workforce each year to improve performance, Morgan Stanley does not have such a staff reduction program.
Some analysts have questioned Morgan Stanley’s plans to gain market share in the bond trading business.
JPMorgan analyst Kian Abouhossein â€” who earlier said that Morgan Stanley should give up that goal â€” expects Wall Street banks to report a 10 percent decline in revenue for the fourth quarter, compared with the previous period.
Bernstein Research analyst Brad Hintz, a former Morgan Stanley treasurer, said in a report on Wednesday that layoffs are expected in capital-intensive areas of Morgan Stanley’s fixed-income trading business, such as asset-backed securitization, synthetic products, structured credit and correlation trading.
“Investors continue to wonder how Morgan Stanley’s fixed income business will be able to generate steady returns and beat its cost of capital without massive changes to its business model,” Mr. Hintz said.
Restructuring Wall Street
Morgan Stanley Chief Executive James Gorman has pledged to cut costs, and said in July that he planned to reduce overall staff 7 percent in 2012. The new job cuts are in addition to that plan, the sources said, and come just a week after Colm Kelleher took over as the sole president of the securities unit on Jan. 1.
The cuts represent less than 3 percent of Morgan Stanley’s entire estimated workforce at year-end, following other staff reductions in 2012.
“This continues the steady drumbeat of negative news from banks,” said Greg Cresci, a Wall Street recruiter with New York-based Odyssey Search Partners. “It’s hard to tell where the bottom is, given how many banks have made similar announcements.”
Altogether, U.S. financial firms announced plans to reduce payrolls by 38,135 jobs last year, in addition to 63,624 job cuts that were detailed in 2011, according to employment consulting firm Challenger, Gray & Christmas.
“We are seeing a redrawing and restructuring of the industry,” said John Challenger, CEO of the firm. “The map continues to be redrawn in terms of regulation, who the competitors are, and the resources banks are willing to commit to the investment banking business.”
In addition to earlier job cuts at Morgan Stanley and UBS, Goldman Sachs cut 700 jobs during the first nine months of 2012 as part of a plan to reduce annual expenses by $1.9 billion.
Citigroup Inc. announced plans last month to cut 11,000 jobs, including some in investment banking and trading, to save $1.1 billion in annual expenses. Credit Suisse Group AG is also cutting securities jobs to reach an annual cost-savings target of 1 billion Swiss francs ($1.1 billion), while Bank of America Corp. is in the process of cutting 30,000 jobs across the firm in a plan unveiled in 2011 to save $5 billion in annual expenses.
Morgan Stanley shares fell 0.2 percent to close at $19.62 on Wednesday. Its shares are up 15 percent over the past 52 weeks, part of a broad rally in financial stocks.
Reuters Breakingviews Assistant Editors Richard Beales and Jeffrey Goldfarb and columnist Agnes Crane discuss why, despite JPMorgan’s noteworthy third-quarter results, it’s too soon for bank boss Jamie Dimon to get too confident. (more…)
Reuters’ Jennifer Ablan and Breakingviews’ Antony Currie say that, after Moody’s downgraded ratings for several banks, the debt is still a more attractive investment than the stock. (more…)