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Taming Of The Traders

20 March, 2012

A loud roar of approval breaks out across the cavernous, crisp packet-littered trading floor in London’s Canary Wharf, as robust US employment figures flash past the screens, causing a palpable ripple of excitement and giving the rallying market another dose of vim.

Traders and salespeople seize their phones, hoping that the news will enliven a quiet Friday, but their hopes are dashed. Despite the positive US data, trading remains relatively muted. One trader eventually leans back, crosses his hands behind his head and surveys a sign adorning a nearby bank of flickering screens: “Sod Calm, and Get Angry”. Yet there are few signs of tempers fraying.

Trading floors are arguably the closest anyone can get to the engine of raw capitalism. Millions and billions of dollars worth of currencies, shares, bonds and other financial instruments change hands at dizzying speeds.

Yet those working in the engine room have been dramatically changed by the financial crisis and, in some respects, trading floors are far removed from the crucibles of testosterone-fuelled finance they were for much of the past few decades.

Many of the “barrow boys” of the City of London and the old-school Italians of New York have been replaced by quieter, more measured traders, often well-versed in quantitative and technical analysis, where fiendishly complex models often overrule instinct. As a result, the job is moving further away from its clichéd image of the cowboys of finance.

“It’s a different world now . . . The characters have gone,” notes the middle-aged head of corporate bond trading at a leading global bank, almost glumly. “I feel sorry for the younger traders who will probably never experience what we did back in the day. It was completely wild.”

Several factors have combined to tame traders. Banks have imposed checks on risk-taking to rein in some of the more egregious trading habits of past decades, such as imposing limits to position sizes and riskiness. Those checks look likely to increase in number and severity given the regulatory changes that are planned. While the exact shape of these rules is still to be determined, they are very likely to entail restrictions on trading, particularly at big banks.

Chief among them is the “Volcker rule”, part of the US’s Dodd-Frank regulatory overhaul that is due to take effect in July, which would ban banks from “proprietary trading”.

Prop trading, as it is often known, is when banks use their own capital to make financial bets. Many bankers and traders argue that a strict interpretation of this would prohibit even legitimate trading activities on behalf of clients – and drastically curtail liquidity across a range of financial markets.

“The Volcker rule and other regulatory changes constraining risky positions will really hurt the income of banks’ trading operations,” says Scott Cameron, a partner of Reed Smith, the law firm.

The Volcker rule will primarily affect US institutions, but almost everyone will have to contend with the revised Basel III regime, a global rulebook that sets out more onerous requirements for the amount of capital banks must keep in reserve for activities such as trading. The European Union is even discussing a tax on financial transactions, which would hammer trading, if implemented.

“We are going into a dark tunnel of regulatory constraints on trading, and the effects on markets are still uncertain,” says Roy Smith, a professor of finance at New York University’s Stern School, and a former partner at Goldman Sachs. “We’ve been on a 20-year journey towards more deregulated markets, but the pendulum is swinging back towards more regulation.”

The increasing complexity of markets also means that few modern traders can survive on perspiration, gut instinct and machismo alone. Instead, sharper suits and minds have replaced many of the grizzled, older traders. This trend has been apparent for well over a decade, but has been hastened by the financial crisis.

“Trading has become far more technical and ‘quanty’, and you see far fewer people without degrees,” says a senior US bond salesman in his late 30s. “There is more intellectual firepower on the trading floor these days.”

Salespeople work closely alongside traders and manage the relationships with important clients.

When Prof Smith was Goldman Sachs’ London-based international president in the 1980s, some of the bank’s most successful traders were driven by instinct. “These days, they’d be considered dinosaurs, and lacking in the right skills set,” he says. “The trading requirements have been upgraded.”

In addition to the institutional curbs imposed by banks, politicians and regulators, memories of the crisis have also acted as a natural brake on the more excessive risk-taking by traders, the traders themselves concede. The emotional scars left by the mayhem run deep with many.

“The crisis felt like a nightmare. I think I’ve blacked it out,” says a government bond trader. “It just felt like it was all over. It was real fear.”

The corporate bond trader says that at times, “it felt like we were just a few decisions away from capitalism unwinding completely and irreversibly”.

Despite the doom and gloom, more considered and disciplined trading may not be an altogether bad thing for banks. A research paper jointly conducted by London Business School, the London School of Economics and the Open University – in which more than 100 London-based traders were interviewed and studied – concluded that the best traders were more in control of their emotions, and tempered their “gut feel” with analytical information.

The study showed that traders who made the most money – a proxy for their skill – were often those who said they were inclined to make more considered trades rather than act on raw instinct. “Effective emotion regulation seems to be a critical success factor in trading,” the paper stated. “Lower performing traders may rely on feelings alone, and show less propensity to think critically about the source of their hunches.”

Nonetheless, although trading may have been tamed a little, it remains an overwhelmingly male domain, with language that would almost never pass the lips of a well-heeled investment banker flying across the trading floor as often as numbers cross the screens. Moreover, many argue that instinct and aggression are still integral characteristics for successful traders, and will continue to remain important.

“At the end of the day, models cannot pick up a good trader’s feel for a market,” says one salesman. “Given the enormous amount of information available, you can easily get analysis paralysis but in the end, you have to make a call – and that is often done on instinct.”

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Taming Of The Traders

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