Yesterday I wrote about the concept of banks being barred from betting on the bonds and equities markets.
“Own account” trading disappears and the only folks who can “speculate” are those with their own chips to play in the game: the private equity, sovereign wealth, high net wroth assets and their asset managers who back all punts with collateral and cash.
In other words, the current players who systematically internalise will leave.
Bear in mind that a systemic internaliser is defined as a market maker who regularly trade off their own book of business:
MiFID provides that a firm should be treated as a systematic internaliser if it deals with client orders in shares on an “organised, frequent and systematic basis” from its own business account. These shares would normally be traded through an exchange or regulated market, but the investment firm is basically holding the shares themselves, waiting for the right price to match.
Some fear such trading is risky and allows banks to buck the price because the banks themselves can trade for their own benefit through such internalisation, known as prop or proprietary trading.
It is this trading that is now being targeted as being unacceptable, according to the American Volcker Rule.
The “Volcker rule”, named after Paul Volcker the former Federal Reserve chairman who proposed it, would restrict the ability of banks trading for their own benefit.
The Volcker Rule, along with others such as Vickers, could push systemic internalising out of the banking sector and, as mentioned yesterday, such that trading is purely operated through funds and asset managers who have the collateral.
So who would this impact?
We mentioned Goldman Sachs and Morgan Stanley in the USA yesterday, but the main European systematic internalisers are BNP Paribas, Citigroup, Credit Suisse, Goldman Sachs, Knight Equity Markets, Nomura, Royal Bank of Scotland N.V. (ABN AMRO as was) and UBS.
Now I know I’m pulling the chain a little here but let’s just say that all these guys trading desks, due to regulations and bonus restrictions, see mass exodus.
What is the future?
What does this mean for investment banks?
It means they purely become platform providers.
A little like the City of London describes itself as the Wimbledon of finance – we have no players, but provide the best courts to play upon – future banks will provide the infrastructure but not play.
So the world’s investment markets purely become technology oriented platforms which players plug into to play.
The market makers and systematic internalisers become technology firms, offering the fastest execution at lowest cost with best price, and the high frequency traders in the hedge funds, private equity firms and others trade.
They may trade on their own account or on behalf of sovereign wealth funds and institutional investors, but they trade with collateral, not with depositors’ savings.
And by offering the platforms to trade effectively, the systems move everyone towards best execution.
Best execution is all about trading at fastest speeds at best price and lowest cost, with a guarantee for the likelihood of settlement.
Somehow I can see the regulators being sorely tempted to follow this line of thinking as best execution has been embodied in European and American regulations for some time.
Mind you, you don’t have to think that this is necessarily going to happen as I’ve just re-read the last write-up of the Volcker Rule in the New York Times:
When Paul Volcker called for new rules in 2009 to curb risk-taking by banks, and thus avoid making taxpayers liable in the future for the kind of reckless speculation that caused the financial crisis and resulting bailout, he outlined his proposal in a three-page letter to the president.
Last year, when the Dodd-Frank Wall Street Reform and Consumer Protection Act went to Congress, the Volcker Rule that it contained took up 10 pages.
Last week, when the proposed regulations for the Volcker Rule finally emerged for public comment, the text had swelled to 298 pages and was accompanied by more than 1,300 questions about 400 topics.
Somehow, as with all regulations, it’ll get messed up on the process, whittled down and weakened until it’s a shadow of its former self.
One can dream.