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Zero Hedge Is Delighted To Hear That Goldman Plans To Spin Off Its Prop Trading Desk
As regular readers know too well, a long-running peeve for Zero Hedge has been Goldman's purported ability to take advantage of its huge monopoly in flow trading to the benefit of its prop positions. In fact, Zero Hedge has engaged in direct communication with Goldman in the past on numerous occasions, in which we have alleged that Goldman's prop desk is bad, and Goldman, logically, took the opposite side. We have just learned that Goldman, according to CNBC, is preparing to spin off its entire prop trading division. We consider this a huge victory for capital markets, if indeed this rumor is true, and a huge loss for Goldman, which contrary to representations by Messrs. Viniar, van Praag and others, probably generates well over 50% of its revenue courtesy of some form of interaction with its prop desk. This is a small but critical start to fixing the improprieties of a leaking Chinese Wall" flow-vs-prop problem, that has allowed a two-tiered market to flourish over the past several years.
From Reuters:
It would be the first move by the New York-based investment bank to adapt its business to comply with the U.S. financial reform package signed into law last month.
One analyst said such a move would be a positive for the bank, and Goldman shares climbed 1.7 percent to $155.77 in early-afternoon trading.
"It gets them out of the way of the Volcker rule without causing any deterioration in their earnings. Therefore it's a significant positive," said Dick Bove, analyst at Rochdale Securities.
A Goldman spokesman was not immediately available for comment.
Under the Volcker rule, named for former Federal Reserve Chairman Paul Volcker, banks are restricted from proprietary trading and have new limits on the size of private equity or hedge fund investments. Proprietary trading has been a key source of Wall Street investment bank profits.
The rule was a key, and sometimes contentious, provision in the financial reform legislation.
In recent months, Goldman has been a focal point for critics of the financial sector's ills leading into the 2008 crisis.
On July 16, Goldman paid $550 million to settle U.S. Securities and Exchange Commission civil fraud charges over how it marketed a subprime mortgage product to institutional investors.
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Sounds great, until we later hear how they're already making up this profit to be lost.
Cool avatar.
Thanks, many more here:
http://www.flickr.com/photos/greenpeaceuk/sets/72157623796911855/
You gotta be kidding yourself if you think Goldman willingly did something to decrease value to its shareholders (and themselves). They found a way to turn what appears to be a negative to us mere morts into a positive.
No doubt.
I'll be the first to say I'm probably not the sharpest crayon in the ZH box, but does anyone REALLY believe GS is going to do something that will actually hurt them??
Yes, they would... IF they were forced to.
I think that this was negociated as part of their SEC settlement. Consider the following:
- this is a huge hit to GS (prop trading accounts for 50% of total revenue)
- they were dead to rights guilty on very serious infractions
- their monetary penalty was a pittance compared to the overall consensus expectations
- the timing of the announcement (less than three weeks since the settlement, but not too close so as to prompt others to draw the connection)
This allows the gov't to properly "punish" GS to the extent that they felt was necessary, YET allows GS to save face with both their clients and the general public (something that tens of millions of dollars in campaign contributions should be able to buy for you). Remember, everyone said that GS got off easy on their monetary settlement.Thoughts?
"It [the spinoff] gets them out of the way of the Volcker rule without causing any deterioration in their earnings. Therefore it's a significant positive," said Dick Bove -
X-CUZE-ME, but could smeone please explain how it WON'T lead to lower EPS?
It can't be bad for Goldman, otherwise they'd written the law differently no?
Bingo.
Accoring to Richard Bove(reverse market indicator), if GS spins off it's prop tradig biz, it will help it's earnings growth.
HUH?
The Broad St bullies do not just give away their competitve advantages easily. I, for one, think that there is more than meets the eye on this one. Cmon. We are talking about one of the best managed companies in the world. Goldy will probably just take bigger and more aggressive positions on the individual trading desks.
Read between the lines: Goldman knows that it's prop trading desk is at peak value right now, and will be less valuable in the near future.
So that can only mean the market will stagnate for the foreseeable future?
You don't spin off a highly profitable unit, unless you know that it's value to the company has peaked -- and can be sold (currently, but maybe not later) at a wicked multiple.
The question is: Has the value of the trading desk peaked because of a perceived market top? Or has its value peaked because it may represent a legal/regulatory liability to the company?
Either way, I'd say this is sort of a top-call, since there are only a couple of computers trading this market anyway...
A top implies subsequent bottoming, and from my layman's view revenue is generated by movement in either direction (though I guess it depends on one's existing positions.) Ergo, not a top but a plateau?
OTOH, HFT is clearly outside of public support and if one of those machines has twirling banner that reads "ppt bitch" in the off hours maybe GS figures the game is no longer sufficiently rigged in their favor. (Voters don't want 1800 about as much as they don't want 800.) Am I too late to print up bumper stickers that read "Low pass filter HFT?"
I do have a physics job in the day time, and no plans to quit ...
Good point. They can get a premium valuation as their 'reputation for trading' is at all time highs, and people are mistaking their ability to borrow for free and trade a steep yield curve (now flattening) as 'talent'.
Excellent observation.
Great thought Popo....
Consider that under the final FinReg, they have till 2020 (?) to divest them selves of such. So why not take in some more marbles from another hand willing to pay top dollar, for in the interim they'll be able to rebuild it in anticipation of the law being changed.
Or just naming it something different.... Sisters of Perpetual Redemption Charitable Good Works and Virgin(ia) PAC Contribution Foundaton.
Will they spin off the prop desk without it actually moving geographically? Sort of like the Gold in the FRB-NY can be send "out of the country" and brought "back into the country" just by wiggling their little finger. Or more likely will there be extra-large com cables between the former prop desk and the former flow desk, if in fact they do inhabit different buildings? "Oh our **former** prop desk? Well, we need to keep chin-to-chin with them because of old business we continue to sort out."
This. It'll take months to make the organizational change let alone an actual physical desk move to an appropriate location. This lets GS book double $$ for both the spin off (at peak value before SkyNet steps in) and their flow-prop relationship. Watch, in 2-3 quarters when their earnings are still trading driven all of those stary eyed analysts who trip over themselves to gush about how good GS is now will still be saying the same thing.
This piece of candy to the U.S. financial reform package is as suspect as a piece of Halloween candy from the kindly neighbor. Better have 911 on standby. Trick or Treat!
I'm not sure but I suspect this is just another Goldman trick. They will dump a bunch of B list traders into this new prop firm and save a ton of money and reduce earnings volatility. Under the watered down Fin Reg they can still do prop trading in stealth mode with their A team in their new "safe" investment bank.
The suckers buying into to this are gonna regret their buy blocks fo sho!
I'd have to see the details. What are the strings? How much capital is going with them and how will that be funded......what does it take to wipe out the entire prop desk and will Goldman Sachs (the Fed, etc) let that happen....what have we really accomplished will be in the details which I assume no one will be able to see
OK, since this thread may cause the others to quickly become stale, I'd like to respond to this comment:
I understand what you're saying, but I still believe a significant portion of decision makers actually believed in the ultimate efficacy of the comprehensive range of reflation policies that were initiated & approved.
The reason for my belief that truly irrational people exist, rather than all are purely rational sharks cruising for fools? Two-fold:
First, CogDis provides plenty of anecdotal evidence that his client base, which is represented by highly educated professionals, still for the most part believes the official narrative.
Second, my Ivy league educated wife, who is a junior miss executive @ a TBTF related firm & acknowledged subject-matter expert in the core legal underpinnings of the entire ponzi, thinks I'm attracted to "conspiracy" web sites.
Since I'm the number cruncher in the family (having spent my career in JohnyBravo's aspired-to-profession), she feels she is absolutely under no compunction to bother to understand our underlying financial system.
To her, the law is the law, governance is governance, and finance is finance. Each to their own, and the system as a whole will eventually work its way out.
So, as you can see, there's a reason why I believe a (significant) majority of the people, including perhaps many of our so-called "leaders", including one Benjamin S. Bernanke, may actually believe the myth.
The numbers of those who understand the nature of the (exponential) system governing both resources & debt, who understand history, and who understand human psychology AND who are able to pull it all together in an encompassing macro view may not be that prevalent - even amongst the power-elite.
+++
the system is running as the system is designed to do. those in charge of pulling the levers of the system are both products and beneficiaries of said system. thus to question the system is to question the purpose of their entire life's work. very difficult for any human being to do without an external shock applied that is strong enough to cripple the foundations of the system (system of governance & rule of law, system of thought & education, system of belief & identity).
the shocks that came in 2001 & 2008 may have been strong enough to knock some of those climbing the tiers of the system off kilter enough to begin the process of self-examination. however those at the top are insulated well enough by wealth & attention (there is a reason why there is a fascination with celebrity -- attention is energy) to only faintly hear the inner rumblings. however, they have all been trained to respond to those rumblings by either denial & repression through self-medication or attacking the symptoms using the weapons of victimization.
there is a reason why the system was designed as a pyramid. what is interesting right now is how long the levitation system that keeps the top floating above the rest will continue to work as the foundation below begins to erode into piles of dust.
keep it comin, B9, you're on fire lately.
In all the discussions with GS did they ever explain how they maintain Chinese Walls when their own software system makes it impossible?
An ex GS guy posted something on his new tech startup website, which was picked up by Business Insider.
The bit that got my attention was this about the risk management software:
"Unbeknownst to most of the non-strategists, you could see basically every position and holding across the company, whether you were supposed to or not"
Read more: http://www.businessinsider.com/former-goldmanite-this-might-get-me-sued-...
If you go to his site this section has actually been edited already and removed
http://adgrok.com/why-founding-a-three-person-startup-with-zero-revenue-...
According to this guy it's impossible for GS to maintain Chinese Walls because of the software
We have made this point for well over a year.
This guy worked on the firm's software system. He says everything went through this so the partners could manage total firm risk in real time and states that everyone can see everyone's position even if you're not supposed to.
When he made the statement I don't think he understood the importance of it. To him it seemed like an amusing bug.
But it means that there is proof that there are NO Chinese walls at GS as the software system makes any such walls meaningless. It also shows that GS didn't even try to erect walls or they wouldn't have allowed that 'feature' to remain
Not only did Tyler talk endlessly about everyone seeing all trading positions but I seem to remember some ZH articles talking about GS seating plans. Meaning there wasn't even a physical separation (a la Chinese Wall) between the GS tentacles.
When Zero Hedge is back from vacation this weekend, we will post the full GSET datadeck. We are confident it will fill many holes in our readers' knowledge on everyting ranging from REDI to Sonar to Sigma X.
doesn't look like you are on vacation..
A study by Britain’s Institute of Leadership and Management reveals that more than a third of managers surveyed say they work while on summer vacation. And 80 percent of those respondents say they frequently check and answer emails, the UK’s Telegraph reported.
As you could imagine, bringing your Blackberry on a family vacation has to take some of the fun out of it. To that end, 40 percent of the 2,500 managers surveyed say they return to the office feeling no more relaxed than when they left.
http://www.publicradio.org/columns/marketplace/business-news-briefs/2010/07/study_most_managers_check_emai.html
GS is now issuing a denial.
http://www.businessinsider.com/goldman-pr-actually-no-one-can-see-basically-every-position-at-goldman-2010-8
Now I really believe it
R U C O M I N'
or going?
Vacation? we have no time for a Vacation
Well...I guess the power elite definitely saw the last 2 crashes coming too...right?
I mean if Bernanke just recent recouped 2009 losses then that must mean his all in again...right?
Sucker! You really buy into this story. It's either a harbinger of
1. market collapse;
2. further cartelization;
3. both.
I'm (not) surprised ZH has bought this nonsense, considering the petit bourgeois/psychotic outlook of ZH authors. Think Norman staring at Marion (Mom is NOT happy).
Welcome back John Ryskamp
ZH for the win!Excellent work as always Tyler...thank you very much.
BTW, GS is Evil...formally speaking.
DavidRicardo, you just got outed.
i prefer schizophrenia over sociopathy any day, but that's me.
One is self destructive and the other is destructive of nearly everything and everyone else except the self.
Of maybe I should say destructive of everyone else until finally the blow-back destroys the self. But in a world where success is measured in who has more toys at the end, sociopathy seems to rule.
The Master briefly looks up from his tea and says, "I do not know." Then he quietly continues sipping.
http://www-usr.rider.edu/~suler/zenstory/zenstory.html
I forgot my <sarcasm> tag. Sorry. :>)
BTW, how was the tea?
no need for sarcasm amigo, your point is well taken. just sharing an alternative view to what we in the west have been taught about the Self to chew on. is the Self a permeable membrane endlessly intersecting & mutating with other membranes or a hard shell (hiding a oft & gooey center) in constant conflict with other hard shells (with soft & gooey centers)? good question and the answer may illuminate why our culture condones (& sometimes celebrates) sociopathic behavior while salivating over the details of when a celebrity succumbs to schizophrenia.
no tea for me today. got a pound of yerba mate from the lebanese market last week and that's doing me just fine, gracias.
Any relation to Ricky Ricardo from I love Lucy?
you'd have to be pretty optimistic (umm naiive?) to believe gov't regulation will achieve any of the stated goals.
It will, however, continue to persuade the sheeple that big brother is looking after them and they still don't have to do their own DD.
This bides time for GS to:
After the sale and one time profits, they will still struggle from the damage done to their reputation and the slowing economy.
Hopefully, the SEC will eventually make an attempt to address the HFTs, preferably before the sale; that would knock the sale price down considerably.
F**k Goldman
they'll probably rape and pillage with extra gusto now that they're selling it anyway
or will they?
mother f**kers need to be shut down
What will be left after the spin-off (no joke)?
Spin off its HFT Computer Trading unit. Then everyone will find out the SEC is Baning HFT. So, anyone buying into the sale will get reamed.
I think you are right. That's the good news. The bad news is the spin off happens in 6 months, meaning the SEC is going to allow the criminal HFT to continue for another 6-12 months.
You guys didn't get my joke... They say that 10% of their revenues are from prop trading - When in fact it's probably more.
Even if the computers are truly Chinese Walled, what is going to stop the traders from chatting to each other over lunch or over the phone? The squid are insiders and game the system, no denying that.
The world is a vampire......
No tickie, no plint out.
Updated DOW daily chart:
http://stockmarket618.wordpress.com
Tyler, when they say they are going to spin off the proprietary operation, will GS post spin still be able to do prop trading that is "related to customer order flow". Will they still be keeping the profitable prop trading (the trading based on their knowledge of customer orders)? Thanks for any response.
Good question and more details needed before response can be attempted
Arent "chinese walls" in place anyway? Whats the difference, besides layered LLC`s? What going to stop any potential gaming now that didnt stop any before?
Baaahhhhhh.....
True that. Its all about "appearences". Protocols will be put in place for making it impossible to prove anything illegal happened.
Its all for show.
The lawyers will make more money. Laws will be passed that are supposed to make the system more honest, but in effect just complicate things, so that a team of high paid lawyers and accountants can figure how to beat the system again, and things become so complicated no one even bothers to question it.
GS doesnt make huge profits from prop trading, they make most of their money by using very large leverage to finance clients short term trading this was allowed by the government not a long ago!
Long GS
I don't see how this is any different? They'll still be frontrunning us retail investors. Regardless if they're a publicly traded entity or not.
Sounds like same thing, different name.
-
Do GS's "market-making" HFT operations even count as prop? GSAM doesn't: I daresay their best prop operations will be moved over there before the sale. So what will they be unloading, exactly?
CNBS Breaking News:
Goldman Sachs spins off into Laundromat chain stores. Market confident that there is 'money in laundry'. GS stock soars.
Chinese Wall, Ha! I want to know where the spun off prop traders will actually be sitting. Will they truly be at arms length from their old flow partners or will one still scratch when the other one gets an itch?
I agree it's a good thing for the markets, if it's real. Of course we'll find out some time down the road what the inside payback for all this was, but, who cares. We'll all be better off in the long run by eliminating some of the bias and foavoritism in the markets.
If nothing else, it's fun watching Goldman Sachs pretending to be a Mr. Nice Guy. Kind like watching Paris Hilton try to sing.
Huh ?
Change the label ...and all is well ?
Rename it ?
How about physical and monetary separation ?
Or is this what is actually happening ?
Or is one suggesting cannibalism ?
Cannibalism...I would think not....
Up in one account ....down in the other ?
ok, where's the catch?
So little information and so many proclamations. There is so little meat to this story so far that it means nothing. The 'Volcker Rule' is so badly written that intelligent commentary is very difficult. The public 'debate' on the issue of "prop trading" is so uninformed that it is mostly meaningless.
Most of the accusations I see regarding GS' prop activity here imply (or specifically say) GS is acting illegally. Like a lot of public debate/commentary on financial matters over the last 2 years, very few people know enough of the details to do anything but jump to conclusions. There are subtleties involved in the trading business such that, even if conflict management is implemented with an over-abundance of care, uninformed commentators will accuse brokers of wrong-doing when they are whiter than white. Most banks trading and risk operations are so integrated, and the Audit departments of most major banks and brokers wield such power and have such tools at their disposal that simple things like front-running would be impossible to get away with. "Pure prop" has periodicity scales ranging from high-frequency scalping (thousands of orders to market per second) to debt workouts and private equity investment. The question about what is appropriate always comes down to "Is there ANY customer information involved in the formation of your trading decision and if so what is it?" and ANY prop trader or Trading Manager who can't answer that truthfully in a way that satisfies the vast majority of the informed customer base should not be doing what they are doing. The problem lies in getting the two together. Customers (Buy Side) often do not have the bandwidth or experience to deal with anything as subtle as conflict management of the Sell Side.
The only real solution to the existence of such potential conflicts is to eliminate OTC markets, eliminate the requirement to go through a broker to reach the exchange, and eliminate principal facilitation as a concept from markets. Every market participant who gets into a position has to do so on exchange and do so blind. And they have to get out of their position in the same way. Market-makers would not be required to provide liquidity - they could pick and choose when they want to market-make and what they wanted to market-make and they do so blind as well.
If that sounds like it is going overboard, then people have to accept subtlety, conflict management, and the potential for issues. I have seen lots of accusations/assumptions over the years in the prop/principal model and how it fits in with customers, mostly from people who 'heard something about something' or 'suspect that it has to be the case.' The assumptions are, by and large, completely ill-informed, and largely wrong.
I agree that current rules and practices in the US allow HFT operations to make money in ways that I find patently objectionable because of the explicit unfairness (or monopoly pricing power) involved. I think the same thing of the US real estate industry, the medical services industry, online data collection industry, and any number of other service industries. I think the same thing of many mis-managed government services. Legislation is enacted by short-term legislators who are, by definition, conflicted (whether it be by lobbyists who want nothing changed, or by having to pander to an uninformed public who wants legislators to go overboard), and who have the attention-span of my 8-year old to boot.
A lot of what you say I agree with and what I say isn't intended exclusively for Goldman Sachs. As stated, the problem is the overlap between being a trader and being a market maker.
Market makers take the inventory risk in exchange for a bid-ask spread, and that is fair. But how the heck can you entitle a market maker an semi-arbitrary bid-ask when they can trade off the information too? It creates a market with far too much concentrated power.
While complexity and conflicts are a part of any business, I don't think it is far-fetched to clearly separate market-making and trading.
Goldman is a prime broker, and they can survive quite well funding hedge funds.
”A lot of what you say I agree with” right back at you. But, I have an issue with...
The answer to that is of course they may (with the caveat that given the automation of and competition between market-makers, I don't see how bid/ask spreads are semi-arbitrary). If I am a market-maker and I carry inventory risk in return for bid/offer spread, I should not be forced to give up my inventory on the offer and not buy on the bid if a customer wants to buy on the offer at the same time some other customer wants to hit the bid. I should be able to facilitate them at the same time. If it means I have to move my bid up, in order to buy in front of other market-makers, because I really want to buy because I know there is another buyer lifting my offer, that is fine. That is market-making. If I also want to keep my long position for a long time, and NOT be the most aggressive offer, I should be able to do that. That is trading. Market-makers who make external markets on exchange may have to follow rules. Market-makers (facilitation traders) who make markets to customers do so on a private exchange (i.e. no rules on what markets the market-makers are supposed to provide. Any low-touch market-maker (i.e. electronic automated MM) isn't going to run inventory which is very large or concentrated. Any high-touch (block facilitation trader) is not going to trade based on what the low-touch market maker sees because the observation period or holding period is completely different.
Any high-touch market-maker worth his or her salt is more in tune with the market in their area of expertise than almost any of their customers. That's just plain good business. If the customers keep on selling Stock A and the market-maker keeps on buying it on the bid, AND the market keeps on going up and the market-maker keeps the position until he sells it out later on to the exchange, and he makes a large profit doing so, was he a trader? Yes. Did he do something wrong? The fact that the market-maker makes any money by buying some customer's garbage and getting out of it means that the customer could have gotten out of it better than he did, so the customer is unhappy. If the trader makes a mint because they buy something that no other customer wants and it skyrockets when customers eventually figure it out, then so be it. Someone has to. Maybe it should be the person who actually did the work and gained the expertise.
As to "concentration of power" issues, everyone seems to want the pricing and service that efficiency of scale allows but noone wants the scale that efficiency of pricing and services requires. You pick your poison.
Thanks for taking time to reply. A market-maker can sell or not sell as they wish... totally their right to act. An example of the problem as I'm talking about is acute in OTC markets when (as you know they do sometimes) markets bust. When the deal is matched book, fine. But what happens when one counterparty is a hedge fund and the other is a dealer's prop desk?
Yes you have novation, but I hope you see my point about the need for separation, especially in this environment. And there isn't even a way of knowing if the dealer is on the other side of the trade. More transparency would go a long way here toward meeting the balance of power issues.
That said, there SHOULD BE a buyer-beware responsibility. Your point (if I understand it) about ABACUS-type deals is well taken. I think the outcry in this case should be focused on the idiots that bought the crap, not on who sold it.
I am not sure what you are getting at.
If Broker A is sitting between a hedge fund and Bank B's prop desk and the underlying goes bust, is that a problem? If Bank B goes bust then so be it. Broker A deals with it. I don't see where the problem is here. Broker A sitting between them has to manage their credit risk to their counterparties. Period. If Broker A decided to short the trade to the hedge fund, and then a couple of days later lays off the risk with Bank B's prop desk, I see no difference. I admit to not understanding what you are getting at, so apologies in advance if I am pointed in the wrong direction.
As to transparency, I don't see where transparency enters into it. I as a client do not want my broker telling anyone on the other side of the trade who I am or what I am doing. Period. If I buy X from Broker A and Broker A finds that the person willing to sell it to me is Bank B's prop desk, or Warren Buffett, or the CIC, it is not my problem. I take my risk and Broker A takes the credit risk of standing between us. That's it.
I was not referring to ABACUS-type deals. I happen to not be sympathetic to the buyers, but I think the reason why GS paid "only" $500mm is that someone whispered in the SEC's ear that this was not winnable, so take what you can get and walk away. GS for its part probably decided that they needed to pay a symbolic large round number to show adequate public contrition, and left it at that.
On ABACUS-type deals, I think that there is another issue, which is that a lot of investors claim to understand the way these things are structured and the risks they are taking on, but in hindsight they clearly do not. When public opinion rages, investors have a look-back option to say "they ripped me off" and deals with stupid leverage and correlation skew risk are not really meant for pension funds.
I'm saying broker A is sometimes sitting between a hedge fund and broker A's own prop desk. You can have a situation where the bid-ask widens (or narrows) to the advantage of the broker's prop desk because the broker is also the market maker. A position can be front-run by the prop desk because they have info from the market maker order flow.
Also, before the crisis a lot of smaller hedge funds in terms of AUM, used only 1 prime broker for custody and dealing. If your dealer's prop desk is behind the trade, it is at least possible that a hedge fund's collateral gets lower than market marks, or the haircut can be higher for the hedge fund.
This is where I see transparancy as a need. Knowing if your broker is also on the other side of the trade is different than disclosing any other client positions... to me at least.
I admit I could be missing something. Big institutions don't see this as possible because they have multiple dealers, custody, and clearing bank relationships. More and more, everybody does now.
I now understand where you are coming from. My apologies for not getting that.
Again I have a few nits to pick. Nobody front-runs positions. They front-run trades. Most market-making desks won't give their prop desks nearly as much info as you credit them with doing. They get paid on what their customers think, not how much money the prop desk makes. Every decent market-maker will know what the unwind price is for a trade and if you have one way on, odds are you are looking for an unwind when you ask for a two-way. So ask him to tighten up and then double up. Or use another broker next time.
If the market-maker moves bid/ask spreads around and they have a position, and so the bid/ask is "tilted" against the HF in favor of the one quoting the price, that's life. You go to a store to buy an item, and you pay the price asked, or you negotiate, but if the price is $5 and you only want to pay $4, you have to go to another store. In any liquid market, that's easy enough to do. If you find all other brokers also quoting $5, you may have to readjust your expectations. If the store loses all its business to the guy around the corner, he will have to adjust his expectations.
I know of no situation where the mark on a trade which passed through a market-making desk would be set by the prop desk rather than the valuation of the market-making desk. For any serious market-maker, 'tilting' marks and keeping track of the tilts is a waste of time. Any new trade will offer more value than tilting an old one, because it cannot be kept up. As long as the deriv pricing in question is somewhat observable, the financial/P&L/product control team (whatever the name of that group is in Broker A) will do their darnedest to use something like Totem to find confirming external marks so a desk cannot move derivs with an observable surface or curve very far that easily. Note also that securities/derivs collateral posted will not be marked by the desk which trade to be collateralized with it. Collateral marking is done by the margining team. The desk which traded the deriv won't have a clue what is even up as collateral. If Broker A wants to make a HF put up more collateral, it can change the margining policy pretty easily. As to haircuts being competitive, if Broker A does not levy a strict capital charge on the prop desk within the Finance/P&L attribution function, the prop desk will have lower haircuts than the HF in all probability. But if the finance desk is not super efficient (and many aren't) and the PB is, then the PB customer may get better leverage and lower funding rates on levered capital than the prop desk does. I have seen that several times.
As to haircuts being different.... They should be. Prop desk haircuts are internal to the firm. But the haircut/leverage/cost of capital of a broker prop desk is irrelevant to the HF. The HF's cost of capital is that which it is. The broker's is different. So be it. A HF's AUM is "free" to the HF. A broker's prop desk has to pay for the "AUM" through funding costs.
As to transparency, if a HF customer trades with a broker dealer in standard OTC markets, I think it should not matter whether the market-making desk took the other side or the prop book took the other side through the market-making desk. In practice, in OTC markets, the market-making desk always does. Whoever is beyond that should not be disclosed. In markets which are agency-based, in some cases it is standard practice to let the customer know whether the other side of an OTC trade is being backed by firm risk or by a layoff to another external customer.
No worries about misunderstandings.
I'm not raising accusations of front-running... I do emphasize the possibility, however remote. Profits have a tendency to make possibility into reality over time. So you go to one of two extremes: complete deregulation, or regulations related to firm organization that make front-running impossible.
Complete deregulation is costly for everyone and in my view not the best option. I think it better to protect the market (ultimately the market makers) against even an appearance of impropriety.
One way to do this is to add transparency, even if it is as simple as clarifiying if one side of a trade is firm risk or matched to another counterparty.
I'd like to think that is the essential point of Finreg, but I can't help but laugh at the notion of those folks knowing what they are doing.
I understand that there is the possibility, however remote, that front-running can occur. Front-running, however distasteful it is in practice, is simply not on the table as a cause of anything. And it is not a reason for the Volcker Rule, or anything in FinReg. It is far more prominent on ZH than anywhere else because it is Tyler's pet peeve.
I disagree that one has to go to one extreme or another. Only extremists need to go to extremes. As a country, we go to extremes only after we have been spanked in a way we didn't like. This is why non-Americans find Americans such hypocrites. That, and the fact that we have our heads up our asses in considering what is most important to us.
While I agree about taking a mean path, politics sadly plays out in extremes.
Don't be so rough on Americans. Everyone is an asshat in their own unique way.
thx. Over and out.
http://www.youtube.com/watch?v=ad3Hzsy1-20
I bet his name was Kartik Athreya or something.
Tyler: Charlie Gasparino at FBN broke this story last week??? CNBC does not get credit!!!
There are certainly a lot of details like that to take into consideration.I read and understand the entire article and I really enjoyed it to be honest.
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