My collective inboxes during a typical week can be rather entertaining and as I am writing this at 40,000 feet I thought I would tip my hat to the correspondent who suggested that my response to the BA flight that went to Edinburgh instead of Dusseldorf last week (I tweeted this was pre-trade TCA gone wrong) should actually have read “Dusseldorf got last looked”.
I am sure there are many more FX themes we can apply to that sorry (but very funny) incident, however I want to go elsewhere in the mailbox for today’s column – banks measuring their voice traders’ success or otherwise in the wrong fashion.
Although it can be innovative, the foreign exchange market has occasionally been caught behind the times, and sometimes – in the case of the chat rooms especially, it was expensive. That episode, which continues to this day of course, threw light on how bank dealers were acting in their day-to-day job, and I remember suggesting that one potential ingredient that led to billion of dollars in fines was P&L pressure in a tough environment.
Following the response to the midweek column, I wonder if the banks are getting it wrong again when it comes to their traders?
As always, feedback took in the spectrum, from those in agreement to those who thought I was living in La-La Land, but one aspect did resonate – the response to my suggestion that re-papering trades could negatively impact a trader’s P&L.
Those traders that got in touch led with the observation that they are not traders anymore, they are merely risk managers, watching and handling orders that the machines cannot handle, or that the clients want watching by a human. This means, they say – and I am paraphrasing of course – that re-papering doesn’t actually matter to them, and it is this factor that got me thinking.
The question is simple as always – are the banks wrong to be judging their FX traders in P&L terms?
I have noted before in this column that during events traders have been effectively barred from taking advantage of a potentially significant move by the presence of customer orders and this came up again during my conversations this week. Two traders told me that during the yen flash event at the start of the year, and after a piece of Brexit news they were unable to make what one termed “serious money” because they simply weren’t allowed to take a position that might been seen as impacting the customer order book.
If you add to the mix a willingness to re-paper a trade made on an honest price (with a reasonable spread!) we have not one, but two potential curbs on the trader’s ability to make money. If this is indeed the case, then how can a bank reasonably expect that trader to make X millions of dollars when they spend most of their time baby-sitting orders that restrict their ability to do their job?
If the banks want to go to that model then they need to find another way of measuring the trader’s skill. It could be in slippage on customer orders, it could be on quality of partial fills, it could even be on discretion applied in fast markets – whatever it is, it would be fairer than saying, “Ok, here’s your desk, go make $10 million without taking a serious position”.
One answer is the model run by NatWest, which has a segregated order desk, this incorporates voice and ‘e’ trades, unlike many other “segregated” order desks that only pass electronic orders to a separate book in the e-franchise. This way, if the trader has no client orders to worry about, they can get on and trade the market. If nothing else it would show those traders who have the skill and those who merely make money off the back of client trades. Of course, for those traders tending towards this model we would have to highlight the perennial struggles of hedge funds to make money as the potential downside.
Another way to treat traders more fairly could be to have a franchise P&L so that everyone contributes and therefore the voice trader feels less isolated – because it is clear to me that many do, thanks to what they see as the handcuffs they are forced to wear when they enter the office every day.
I should stress that these traders are not talking about the ability to take on risk from customer orders – they fully accept the need for transparency and fairness in that area – rather they are suggesting that they are able to take a position in spite of their order book.
As an example, I would recount the story told to me last year of a trader who wanted to sell Cable after some obviously negative news, but couldn’t because he had a client stop loss 15 points away. The news was obviously going to send sterling much lower than the 15 points (if I recall the story correctly it fell around 100 points) but the trader couldn’t sell until the client order was executed and if they had sold and offered the client a fill 15 points above the level they felt they would be targeted by internal compliance as accused of triggering the stop. The result was, as the market move accelerated, they managed to squeeze 25 points out of it – one quarter of what it could have been.
This working environment is dominated by a climate of fear and it just doesn’t make sense. I understand we, as an industry, have to overcome an absolute breakdown in trust thanks to the chat room scandal, but the Global Code and much stricter internal procedures at the banks should ensure that clients are treated fairly. At the same time, however, a client order should not stop a trader entering a position for genuine reasons, and checking their motivation is not exactly difficult is it?
All it would require is for the trader to make a note of why they entered the position and for that to be handled by someone in compliance who actually understands markets and risk (and that is a whole different subject that we shall return to on another day). If there was negative news that the trader believed would result in a significant move lower then how can that be seen as triggering a stop? Anyone with market knowledge would be able to judge whether it was a reasonable assumption, and as such this should ensure that we don’t have traders tempted to go after stops on the most flimsiest piece of information.
It could be they are allowed to enter positions on news-related events only. That removes the risk they will piggy back client flow or orders, but at least it would give traders some freedom to do their job. If a trader repeatedly trades against the orders in their book then suspicions will be aroused (especially if the move stops just a few points past the order) and they can be temporarily stopped from taking positions pending further investigation. The thought of being caught out – and the technology and oversight now exists to suggest they will be – then we introduce that moment of pause that will stop 98% or more of potential wrongdoers crossing the line.
I sense this is an issue the industry needs to look into at some stage, because I have always felt that part of the reason the traders in chat rooms embraced the concept so easily is because they were being pressured on the P&L front – not least by what became the need to pre-hedge large Fix orders – a phrase that hadn’t existed in the market’s lexicon just a decade ago.
If you look at it, the two big issues in the voice world eight years ago were clients sweeping the market (often whilst telling the LP it was “only you”) and the challenge of trying to buy or sell hundreds of millions, sometimes billions of dollars in a one minute window. Both are P&L related and both bred a sense of desperation in those traders, which meant they took a path that in their hearts they probably knew was wrong. This desperation was also clearly felt at higher levels because senior managers encouraged the conduct – they were also looking at P&L, albeit on a broader scale.
It concerns me that by making the trader’s job so difficult, and by measuring their performance in a manner that was fitting a decade ago but clearly is not now, we risk incubating another period of inexorable creep towards those levels of desperation once again as dealers strive to achieve impossible targets.
If that happens, then who knows what the consequences will be? All I can say for sure is that whatever they are they won’t be good, so now is the time for the banks to start modernising their approach to a basic concept of employment – how to judge and reward their staff appropriately in a changing landscape.