Proprietary Trading Firms Lure Potential Spin Outs from Big Banks
Wait and See?
Much of the media attention has focused on Goldman Sachs and Morgan Stanley, the two bulge-bracket banks that have the largest proprietary trading units. "Morgan and Goldman are in categories of their own," comments Schenk. "They've had teams that are very much in tact, and they are longstanding in nature. For them to spin them out, it's no big stretch."
But many observers say it's premature to know what the bulge-bracket banks are going to do since there is a phase-in period to implement the rule. Firms are not required to spin off proprietary desks immediately; they have four years with which to comply with the new regulations. "I don't know of anyone who has a clear understanding of what these measures are and how they are going to impact [firms]," comments Anthony Dostello, managing director at Objective Paradigm, a recruiting firm based in Chicago that focuses on proprietary trading firms, hedge funds and some investment banking firms.
While independent firms are anticipating the spin-offs, they concede that not much has happened yet. "Since there are still four years for the bulge-bracket firms to comply with this rule, there are still a lot of unknowns out there," acknowledges FNY's Motschwiller.
Nevertheless, there is quite a bit of speculation that proprietary traders will jump ship from the big banks and bulge-bracket firms as they await their fate. Although the Volcker Rule has been watered down from when it was originally proposed, it does ban banks from making risky bets with their own capital and limits them to investing no more than 3 percent of their assets in hedge funds or private equity firms, which may be viewed by some traders as too restrictive.
According to Eric Bernstein, COO at Sophis, a provider of cross-asset-class risk management systems, some of the newer hedge funds as well as second- and third-tier banks already have hired proprietary traders away from the bulge-bracket firms. "People thought this was going to pass in March or April [2010]," he comments. "Around that time, we saw a lot of movement," including the departure of Goldman's top proprietary trader, Pierre-Henri Flamand, to set up his own event-driven hedge fund firm, Edoma Capital, in London.
Expanding Into Multi-Asset Trading
Industry players are watching the potential spin-offs, says Bernstein, because the restructuring offers a chance to hire talent in areas that they haven't covered before and to expand into different asset classes. "What makes it interesting for firms like First New York and others is the opportunity to broaden their books," he contends.
"If the firm's specialty is equities, and now they can hire credit traders and commodity groups, that's exciting to them. That's where a hedge fund can go from being long-short equity to multi-strategy right away," adds Bernstein, who notes that while such a shift would increase the complexity of the firm's risk management needs, it also would give them new avenues with which to offset the cyclical returns of other strategies.
On the other hand, some of the asset classes that the bulge-bracket firms trade may be too balance-sheet intensive for the independent proprietary trading firms to facilitate, explains FNY's Motschwiller. For example, an independent firm may not want to handle a strategy involving a highly complex credit default swap strategy that involves ISDA (International Swap Dealers Association) agreements, he relates.
In addition, if the independent firms hire proprietary traders from the large banks, they will need to add and upgrade systems in order to monitor the traders in real time. "Even the start-ups, whether they have institutions or private investors as clients, realize they need systems," says Bernstein. "They need robust systems because typically proprietary traders trade everything - equities, commodities, derivatives, swaps, anything they can profit from. You need very robust systems to handle that cross-asset capability and to monitor and quantify the risk they're taking." Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio
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