Amid warnings of dire consequences if regulators clamp down on risk-taking by big banks too aggressively, many financial groups are in turn preparing to step into the role once occupied by global dealers.
Many marketmakers and other groups that previously operated opposite the banks now see an opportunity to become major participants in fixed income and derivatives. Those markets are being pushed by regulators to more closely resemble the decentralised, highly electronic global equity markets.
Under pressure from impending Basel III capital requirements and “Volcker rule” restrictions on proprietary trading, banks’ revenues are suffering and bonuses are being cut. Trading volumes are persistently low in many markets, and Federal Reserve figures show banks’ inventory of bonds falling to new lows in January.
“In a world where regulation says [banks] can’t own more than ‘X’ per cent … I think we’re going to be looking to a new breed of leaders,” Richard Prager, head of global trading at BlackRock, recently told an industry forum.
To prepare for that role, groups such as BlackRock, which recently began matching some trades internally and clearing its own swap trades, are tapping former bankers such as Mr Prager, who left Bank of America in 2008.
This week, Getco, the Chicago trading firm that began in high-speed equity market-making and is now one of the biggest proprietary traders of equities, options, futures and currencies globally, has named Daniel Coleman, former global head of equities trading at UBS, as its new chief executive.
It is the most recent in a string of such moves. Getco last year hired its head of fixed-income trading from Goldman Sachs. In January, Peak6, a Chicago options trading firm, also hired a former UBS executive. Prop traders from banks such as Morgan Stanley and Citigroup also have been moving to hedge funds and trading firms.
Mr Coleman first left UBS in 2010 to join Getco after seeing the changes that were just beginning to sweep over banking. After interviewing at several places, he recognised Getco as the natural home for his talents – which he originally developed at O’Connor & Associates, an ambitious Chicago prop shop that was absorbed by UBS in the 1990s.
“The world is clearly changing, but things have begun to remind me of the times when I was happy in my career. I feel I’ve gone full-circle,” says Mr Coleman.
Mr Coleman, a native of Alabama, recalls reading a story during his college years at Yale about LA Law, the television show about glamorous lawyers in Los Angeles. It argued that the country was producing more lawyers than was economically necessary. “I think you saw that with bankers too,” he says. “It’s a good thing some of that talent is going to relocate.”
At Getco, Mr Coleman has set his sights on raising the firm’s previously intentionally low profile by expanding its client-facing side. It now sells its once highly secret trading algorithms to banks, hedge funds and institutions in order to help them find the other side of trades, but without a counterparty that uses deep pools of capital to warehouse risk for long periods of time.
“Clients will still need risk transference, and some of that expertise at the banks will go elsewhere,” he says. “The advantage will go to firms like Getco that get the power of technology.”
Big bank dealers have argued in extensive comment letters on the Volcker rule that without the ability to hold bonds and carry large risks on their balance sheets, it will be harder to make prices in some markets, especially fixed income.
But the view of market-making firms such as Getco and Knight Capital, and electronic platform providers such as Tradeweb and MarketAxess, is that liquidity may be enhanced once the playing field is levelled.
“I’ve seen this movie before. We heard the same things said during the transformation of the equity markets,” says Mr Coleman. “Markets function better when participants have skin in the game and risk is priced the right way.”
At the same time, many big banks are also getting ready to take on new roles. UBS, for example, has recently launched an all-electronic platform for credit default swaps.
There is also worry about new forms of markets. In equities, US and European regulators are looking at changes such as the rising share of off-exchange trading and the surge in high-frequency quote cancellation that they fear may distort prices.
“There are huge liquidity gaps that may be exposed,” says Ari Bergmann of Penso Advisors, a one-time head of derivatives trading at Bankers Trust who now runs risk-hedging strategies for insurers, pensions and hedge funds. “But we are also seeing new kinds of traders enter the market and fill some of those gaps.”
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