Buckle Your Prop Trading Seat Belts – CFTC Hooks Wagon to Volcker

Hints of stiffer interpretations of Volcker rule set off a round of teeth gnashing and budget rewriting for nearly 11,000 trading firms.

Few doubt the current political climate in Washington has inflicted more than a trifling amount of damage to the national economy. That business leaders would be less enthusiastic when weighing difficult capital investment decisions in the face of gridlock and radically vacillating policy interpretations will be a matter of common sense for many, and for the rest Moody’s has attempted to put the matter in statistical terms with their Political Uncertainty Index. Suffice to say there’s more than enough reason to take a sympathetic view towards managers in any economic sector whose business plans depend on a stable tax code, a predictable employee healthcare expense base, or a known cost of accessing the capital markets.

To that list of woebegone business leaders we can add anyone with responsibility for a business even remotely resembling a hedge fund or prop desk in a bank with any size of presence in the US (early estimates placing the number of firms affected at 11,000.) Years in the making, the Volcker rule has threatened a certain level of divestment from these sorts of trading activities, ostensibly before a July 2014 implementation date. But recently, Bloomberg reported that the national Treasury Secretary took the occasion of a recent meeting with top banking executives to warn of a much stiffer interpretation of the rule than had been expected. Adding fuel to the fire, Gary Gensler signaled the CFTC would adopt the reportedly 1,000 plus page rule as well, targeting a December(ish) completion. And so begins a new round of teeth gnashing and budget presentation rewriting around the sector.

Preparation

Operational experts may lack a silver bullet response but they have made a number of fundamental recommendations, the first two of which are now proving obvious:
1. Assume a bearish Interpretation: Based on the comments from Secretary Lew, the warning PWC’s Dan Ryan gave when he said banks will be “assumed guilty until proven innocent” of engaging in proprietary trading look prescient. Banks must take a conservative view of their trading activities and assume activities not fully supported by customer trading flow - inclusive of market making activities - will be considered in scope of the rule.
2. Prepare a governance model now: Whether it be via sell-off, spin-off or some form of joint venture, divestments quite obviously will require a great deal of executive involvement and focus on execution. Our friends at Capco have expounded on this topic eloquently.
3. Identify transformation enablers: Less obvious is the notion that the operational management of any divested entity warrants a fresh analysis given the emergence of a new ecosystem of service providers in the industry, particularly in the last five years. Hedge fund administrators such as Citco can certainly provide a suite of business processing services that can dramatically simplify the firm’s operations and have become a de facto part of most any new firm’s business plan. And now a new generation of technology service providers, my own firm among them, have emerged and proven their ability to spin multi-billion AUM operations out of the largest banks in the world in less than two quarters (managing every desktop, server, application, phone and data repository world-wide in a secure private financial cloud). This presents a potentially radically lower level of operational risk than traditional “rebuild” approaches

Obamacare Fallout Further Complicates the Picture

There is perhaps reason for a more optimistic outlook on the interpretation. As the rollout of the Affordable Care Act has unfolded into a crisis of confidence for the Obama administration, some have speculated the President may take a more subtle tack with the remaining reforms on his agenda. So the crystal ball gazing will continue for some time, it appears. Time to get on with your PowerPoint revisions.

Ken Barnes is the SVP of Corporate Development for Options.

In this capacity Mr. Barnes is a principal and member of the executive management team with responsibility for development of the firm’s product development and strategic company initiatives. After having spent a dozen years in business development, product marketing and trading facilitation roles in the capital markets technology industry, Mr. Barnes joined Wombat in 2005. As head of Business & Planning, he helped the company quintuple revenue in three years and launch the company’s high performance middleware division, positioning it for a $225 million acquisition by NYSE in 2008. Mr. Barnes managed NYSE Technology's Infrastructure business in the US, leading the turnaround of SFTI and the launch of the Mahwah colocation facility in 2009, and subsequently launching the company's Capital Markets Community Platform.