For some time there’s been debate about whether Vickers or Volcker is the right way to go.
Should investment banks be divided from their retailing and commercial siblings by a fence, or completely separated so that one cannot poison the other?
Should banks be allowed to play in the markets off their own account, or should such risky practices be outlawed?
The debate will continue for a while and it’s clear there is a possible revolutionary outcome as, eventually, markets will decide how to behave.
This will be through a mixture of the law of unintended consequences and the law of Darwinism.
For the former, we’ve seen the impact of unintended regulatory consequences before.
When the Markets in Financial Instruments Directive (MiFID) was formulated, everyone believed it would seriously impact the systematic internaliser – the banks that trade mainly off their own account.
It did, but not in the way the regulations intended.
Instead, the regulations opened Europe’s markets to full electronic trading strategies and allowed Chi-X to decimate the traditional equities exchanges’ business.
The systematic internalisers leveraged such facilities, particularly through dark pools, and suddenly the majority of equities trading in European markets flowed through systems rather than people.
It is also why the surge in OTC Derivatives trading arose, some would say, as the human touch in banking moved from trading to creativity.
Now the regulators are trying to rewrite the rules for high frequency operations and OTC Derivatives.
We all know that means that, in the law of unintended consequences, they are again creating a new market structure that they may not foresee.
This is because the Volcker Rule – the rule introduced as part of Dodd-Frank in the USA that bans proprietary trading – means that many of the world’s leading speculators, traders and masters of the universe are already moving out of the banking network and into the investor network.
From Forbes Magazine recently: “The Volcker Rule would impact investment banking giant Goldman Sachs the most followed by Morgan Stanley. The two firms derive 48% and 27% of their total consolidated revenues from principal transactions respectively … Bank of America and JPMorgan Chase see about 9% and 8% of their total consolidated revenue come from such transactions. Citigroup will be the least hit with just 5% of its total revenue at stake.”
No wonder Goldman is seeing a mini-Exodus.
Bloomberg recently reported that Goldman Sachs lost two leaders of its biggest division.
“Edward K. Eisler, 42, and David B. Heller, 44, are retiring from the company, where they helped lead the securities trading division since February 2008 … Eisler and Heller join about 50 Goldman Sachs partners who left the firm in the past 12 months, according to company filings, internal memos and news reports.”
What is today a mini-Exodus is likely to become a waterfall over time, as banks close down areas of business that the regulators make undesirable or untenable such as proprietary trading, along with restrictions around the level of pay rewards by curtailing bonuses.
For example, the law in the UK has changed such that “the practice of up-front cash bonuses has stopped. The practice of guaranteed bonuses has been sharply curtailed, at least in the London market. Bonuses now have to contain a very significant element of deferral. At least 40% of the bonus for a significant risk taker has to be deferred for a period of at least three years.”
Increasing tax, decreasing bonus levels, a tougher job climate – over 200,000 banking jobs were taken out last year – and a general gloom over investment banking – RBS is closing its investment division – all mean that the world of capital markets is being reinvented.
The reinvention is slow at first, but will become noticeable by 2015 and notable by 2020.
What does it look like?
It’s a guess, but the future looks like one where banks no longer participate in active trading and risk.
The trading risks are taken by those who are willing to lose, and they have to have their own collateral and assets upfront in order to be able to play therefore.
That means private equity, sovereign wealth and the high net worth will be the risk takers and trading speculators.
Institutional investors, pension funds, hedge funds will also be in the game.
But banks will not be able to play.
Their inability to play will be partly due to limitations by law – Volcker, Vickers and the like – but more by the natural market selection for talent.
Real trading talent will no longer be won by the banks, due to their inability to pay and remunerate, and therefore others will hire the big guns.
Banks will be forced to focus away from trading and more toward client acquisition and satisfaction.
Banks will become hugely focused upon corporate relationship management, improving treasury returns and demonstrating real value to their clients’ CFO.
Their focal point will be to gain and retain high value relationships at the top tier of the markets, looking after their corporate client’s needs for risk management and advising them on hedging strategies for the future.
A new world where casino capitalism will only be played by those who can afford the chips.