While most market participants clearly find the idea of deposit-taking institutions funding potentially risky trading strategies with client money difficult to stomach, almost half of respondents to the latest TRADE Poll consider an outright ban on banks’ proprietary trading activities equally unpalatable.
Fifty-three percent of respondents to the poll, conducted on theTRADEnews.com throughout February, believe prop trading should be outlawed for deposit-taking institutions, but 47% think the status quo should be maintained.
In January, US president Barack Obama unveiled plans for legislation that would prevent deposit-taking institutions in the US from owning hedge funds and private equity business or operating proprietary trading desks. Seen as a populist move designed to address charges that banks rescued by the US tax payer are effectively gamble with client money, the Volcker rule – named after the former Federal Reserve chief who inspired it – also highlights the potential conflict of interest that banks’ prop desks represent, given their often opaque relationship with institutional client flow.
Some commentators expected the majority in support of a ban to be larger. “While I can find a rationale for saying prop trading is still quite important, if it is simply a question of yes or no, my instinct would be to answer that it should be outlawed,” says Paul Squires, head of trading at buy-side firm AXA Investment Managers.
“I’m surprised it is so close,” agrees Bob McDowall, research director, Europe, at consulting firm TowerGroup. “I would have thought 60-70% would have wanted to ban prop trading where deposits are not ringfenced from trading.”
While it appears that the Obama administration’s Volcker rule seeks to permit proprietary trading done to facilitate client executions, many have pointed out that the difficulty in separating it from pure prop trading could have unintended consequences for risk trades.
However, even client facilitation can have disruptive effects that some buy-side dealers would not miss. For example, if a broker buys or sells a stock in anticipation of a client order, this action could either create or exacerbate unfavourable stock price moves that the client was trying to avoid.
“As a fairly limited user of risk, I would lose the risk reasonably comfortably to gain the benefits of less volatility and less positioning in the marketplace,” says Peter Baillie, senior equity dealer at buy-side firm Martin Currie Investment Management. “Some argue that sell-side traders are doing their clients a favour by anticipating their orders and pre-positioning to be able to offer them liquidity but that has a snowball effect – it creates part of the problem people are dealing with.”
But despite the inherent conflicts of interest, Baillie suggests that restrictions, rather than an outright ban, would better serve the market. “Prop trading by deposit-taking institutions isn’t necessarily something that should be barred, but there should be a lot less or even no cross subsidisation between the two businesses,” says Baillie.
TowerGroup’s McDowall feels that a prop trading ban is unlikely. “In extremis it might have to be put into a separately capitalised enterprise subsidiary of the financial institutions and have other activities totally ringfenced from it,” he says.
The Volcker Rule is intended to strengthen the financial reform package currently making its way through US Congress, according to a White House statement. The reform bill was passed by the House of Representatives in December 2009 and is currently being debated by the Senate. Some news reports predict that the Senate will vote on the reforms this week, and may look to introduce a watered-down version of Volcker’s proposals, which would seek greater supervision of banks’ prop trading activities rather than a ban.
To vote in the new poll on MTFs’ inclusion in European indices, click here