Having already suffered an exodus of trading talent to boutique and agency brokers during the financial crisis, large banks could lose another wave of execution expertise if regulators impose bans on their proprietary trading activities.
While prop desks are focused on making money for their parent banks rather than executing client trades, a loss of prop talent could have a material impact on large banks’ ability to trade effectively on the buy-side’s behalf.
If prop traders find their ability to make money curtailed by restrictions at the large banks, they are unlikely to stick around for long. As one broker puts it, “These are not the type of professionals that would waste time on the sidelines if they feel they are not going to get paid.”
If regulators go as far as banning prop trading by banks outright, even that executed on the main trading desks as an adjunct to the client facilitation business, the large houses could lose more than just their specialist prop traders. Many sales traders at large banks split their time between client and prop trading, and are unlikely to be happy if their jobs are reduced to punching client orders into algorithms. “That would drain the banks’ intellectual resources because it would take away a huge component of the trader’s intellectual interest in the role,” says another broker.
Once these talented individuals head for the door, a wealth of trading experience goes with them, which can mean poorer service for the buy-side.
“Banks learn a lot about how stocks behave by their own proprietary trading and that is advice you can give a customer,” says a broker. “If they ask, ‘I want to trade this stock. What do you think?’, you would often go to the prop trader who trades that stock and ask him how he would trade it. They are experts at what they do.
Not having them materially changes the value proposition of what banks can offer customers in terms of trading advice.”
In addition, many of the advanced electronic trading tools the buy-side now takes for granted, in particular execution algorithms, were initially developed on prop desks. Removing the prop facility could cut off clients’ supply of trading tools.
“The loss of the internal prop teams may lead to banks losing a lot of the quants they have hired on the prop side and who are getting paid to develop those ‘prop’ algorithms that may eventually end up as client tools,” says Simmy Grewal, senior analyst in the institutional securities and investments practice at research and consulting firm Aite Group.
While a bank doesn’t necessarily require a prop desk to develop and test algorithms, as agency brokers with successful algo suites will testify, prop traders’ input can make a difference. “On the prop side you can be a bit more creative with your algorithms than on the agency side, and that creativity might be lost,” said Grewal.
Even if one accepts that portfolio trading desks sometimes play a more significant role in client-facing algo development, the fear remains that removing prop trading will take some of the thrust out of a broker’s client-facing trading desk.
“If you take away the prop component of the trader’s job inevitably you are going to stop them thinking about how they generate alpha and where the alpha opportunities are,” he says. “Therefore I think the client base will end up with a much lesser product offering from the traders.”
To vote in the poll on proprietary trading, click here