Bonus Bonanza Furor

The outrage over last year's bonus pools for the nine largest banks is set to become the next big issue for politicians and, possibly, regulators. The fact that $33bn worth of bonuses was paid out at the same time these banks were close to tipping financial markets into the abyss was not lost on NY Attorney General Andrew Cuomo. His report, released yesterday, expresses his bewilderment that bank employees are rewarded so generously even in bad times. He said: "One thing is clear from this investigation to date: there is no clear rhyme or reason to the way banks compensate and reward their employees." Goldman Sachs, JPMorgan and Morgan Stanley actually paid bonuses that equated to MORE than their net income. Now every financial journalist knows that banks have to pay salaries and bonuses that are similar to their competitors because if they don't they will lose 'talent', blah blah blah. What the nine banks have done, however, with their profligate flaunting of compensation is to ensure that there will be heavy-handed regulation. Their shareholders will crack down on them so hard that they will wish they'd never heard the word bonus. Why, after all, would anyone invest in a bank that pays out more in compensation than it MAKES? I wouldn't. The end result will be that the 'talent', if it has any sense, will move to Switzerland or Dubai or Singapore to continue to get the fantastic bonuses. Plus they'll benefit from lower taxes. NYC and London could be decimated.

Banks to CFTC: "Not Me!"

The comments coming out of the CFTC hearings in Washington this week remind me of watching an episode of Seinfeld. Everyone speaks but nothing is really said. Banks to CFTC: "I thought YOU were putting limits on positions". CFTC to banks: "What? I thought YOU were doing it."
At the CFTC hearing yesterday the head of commodities at JPMorgan Blythe Masters (who as much as INVENTED credit derivatives and is married to the once head of Phibro and now an energy fund manager) said that the CFTC should absolutely put limits on speculators - but only the 'end users' not the banks. Dan Casturo from Goldman Sachs enthusiastically agreed, reiterating that the banks were providing a critical 'service' to hedgers. According to my sources, Gary Gensler, who used to work for Goldman Sachs and knows exactly what the bank provides, as much as winked at Casturo and in so many words said 'I think not.' Masters hinted that business could go elsewhere if the CFTC was too draconian, but that has always been a danger with better regulation. The energy exchange in Dubai was not set up purely to trade Arab Gulf crude after all, and Vitol did not invest in it for the desert real estate value. Meanwhile the UK's FSA has called a spur-of-the-moment meeting with oil market players to discuss whether changes need to be made to FSA regulations. It sounds like someone at the CFTC had a word in the FSA's shell-like. Hopefully the FSA has invited some 'end users' as well.

High Frequency Trading's 15 Minutes?

Is high frequency trading on its way out? Although high frequency trading does not appear to harm anyone particularly, it is certainly getting its 15 minutes of fame and then some. Even CNBC jumped on it briefly, although Maria Bartiromo looked pretty bored when talking to Pipeline and ITG about it the other day. I am waiting for Glenn Beck or Rush Limbaugh to denounce it as the ultimate evil. Meanwhile the London Stock Exchange has said it will stop paying rebates to high frequency traders. The LSE's new CEO Xavier Rolet is either very brave or he sees the writing on the wall. Rebates for volume were intended to draw business to the newer ECN venues such as BATs and Chi-X. They were never intended to be a significant money-maker for traders. The LSE has decided it will end the rebates, even as it loses volume to the European newcomers. It may be too easy, but I can easily link Rolet with the US Treasury and the SEC - both of whom should have some idea what is in the cards for high frequency traders. Rolet used to work for - wait for it - Goldman Sachs. His boss was Robert Rubin. Guess who else worked for Robert Rubin when he was at the Treasury Department? Timothy Geithner. And Lawrence Summers. The guys who are deciding the course of regulation to come. I'm just saying.

Asset Class Conundrum

The aftermath of the credit crisis is beginning to look like an asset class bloodbath. First the overuse of credit derivatives - and the dearth of related risk management - caught the attention of regulators worldwide when they took down some banking giants. Volumes plummeted initially but are beginning to revive now that clearing is less problematic. Then oil speculators are called on the carpet by the US Congress and the CFTC for spiking crude oil prices up close to $150 last year. Other commodities are also in the regulators' firing line. Equities markets have attracted some wholly unwanted SEC and political attention due to several issues: huge volumes trading in dark pools, the proliferation of high frequency trading and now 'flash' orders. High frequency trading represents between 40-70% of daily volume in US markets, depending upon source, and could be artificially inflating trading volumes. Now there are reports that currency trading volumes have dropped by almost 25% in the UK and the US (Asia held up slightly better, falling only about 20%). Icap's EBS electronic trading platform saw its trading volumes fall by more than a third in the second quarter. According to Bloomberg, a 'plunge in risk appetite' drove away hedge funds and speculators. If the risk appetite for fixed income, equities, commodities and FX have all dropped off, and naked short selling is now off the menu, what is going to appeal to traders next? Carbon?

CFTC Hearing Will Reveal Little

I would love to be a fly on the wall at tomorrow's CFTC energy speculation hearing - the first of three. Congressman Bart Stupak and some CFTC bodies will speak. One 'witness panel' is being led by Jeff Sprecher of ICE and Terry Duffy of CME (which owns NYMEX), so it will be no surprise when they recommend leaving well enough alone. The other is led by a couple of lightweight petroleum and gas associations, an airline rep and a rep from the Futures Industry Association. I question whether the honorable Congressman or anyone at the CFTC knows enough about the oil business to ask the right questions. Even before the hearings were scheduled Goldman Sachs said it would apply for an exemption to speculative limits because it offers a valuable service to hedgers. (Goldman appears shocked and hurt that anyone would call what it does 'trading'. But its J. Aron commodities subsidiary does not appear to do much in the way of physical oil anymore, so much of its business must be speculative OTC and futures trading...) No doubt Citi will apply for the same exemption for its Phibro division (which DOES still trade physical oil). If the regulators and our Congressman do what I expect, then all of the largest players on the energy futures markets will remain the largest players. Instead of spending all its time worrying about the $100m paycheck of one Andy Hall, the illustrious leader of Phibro, maybe the government should bring him in on the discussion. If anyone knows how much the energy market has changed in the past few years, it is he.

Time Off from the Financial Markets

I'm going on vacation for a week, so you will have to do without me for a bit. You know when you see Glenn Beck on TV explaining Goldman Sachs' and it relationships with regulators and government that it is time for us financial journalists to take a break. Actually we may all be taking enforced breaks in the future. If McGraw-Hill is selling the venerable Business Week for a dollar we are all in trouble. When I was at Platt's in London, the Business Week reporters were the Gods of the office. Us poor plebes reporting oil prices were holed up in little cubby spaces while they had suites. The Business Week ad salesmen were always traveling to exotic countries to take orders for advertisements - they didn't even have to try very hard to sell them. Every firm wanted to be in Business Week. Times change.
Meanwhile my book, Trust Me, is out to agents and I have my fingers crossed that writing financial thrillers is my next career move. Wish me luck.

Rats Desert City Ship

Almost a third of London's City workers are looking for jobs anywhere but London, according to today's Financial News. The City's history and culture aside, the main reason these people were there to begin with was money. With jobs harder to find, the UK government threatening to crack down on bonuses, and the real threat of a 50% tax band, City workers are taking a harder look at living and working in London. Even if City Boy averages 300,000 pounds per annum that only leaves him with 12,500 a month to spend. The mortgage on his Notting Hill Gate 2 bedroom flat will take 9,000 of that (if he put down the 20% he should have, which he probably didn't). Then factor in nights out at London's most exclusive clubs and dinners at Kensington Place and there is little left for his holidays in Vietnam. FN says that, whereas a London-based banker will receive only 50% of his gross income after tax, in Paris, the comparable figure is 58%; in Frankfurt it’s 60%; and in Zurich it’s 68%. In Singapore it’s more than 80%, and in Dubai it’s more than 95%. Never mind that he will be bored rigid living in any of these places, our City Boy would have enough disposable income to get out on the weekends. London is a remarkable city, full of wonderful museums and restaurants and theatre. But it has become punishingly expensive and the tax burden is untenable. Maybe if more City Boys leave it will become affordable again.

Spinning Gold out of Straw

Goldman Sachs' second quarter earnings jumped by 65% led by staggeringly good results in its trading of fixed income, currencies and commodities. The bank made excellent use of the cheap money available from the Fed, and spun the straw into golden profits. I have no issue with this, that is what inventive money makers do. But the general public is outraged that taxpayers' money should be spun into huge bonuses for greedy bankers. This is the tip of the iceberg. If the general public knew what the banks were up to with their high frequency trading they would flip. According to Tabb Group high frequency traders now control almost 75% of US equity market activity. Tabb says they generate over $20bn in profits, and clearly Goldman's gets the lion's share of this. Although these firms represent only 2% of the 20,000 US trading firms they do three-quarters of the business in US stock markets on a daily business. This is a staggering figure and shows just what a house of straw the listed markets really are. This is where the bulge bracket banks are really spinning the gold. The head of JP Morgan's algorithmic product desk Carl Carries wrote in the Journal of Trading that high frequency traders 'feast upon the signals of others' and that dark pools are the place to be to avoid detection. Few retail and even institutional investors have access to dark pools, although their brokers may. And it is unlikely that they are getting good fills. It is more likely that anyone who is not a high frequency trader who is dipping his or her toes into the stock market is getting stung. I wonder if Tim Geithner is looking into this?

The Truth About Oil ETFs and Index Funds

I was incensed when I saw the press release from ICE yesterday basically begging the CFTC not to employ position limits on certain energy market players. ICE's release pointed out that only last year did the regulator conduct studies that concluded that 'supply and demand' were behind the unprecedented price rises. That part is true, but the 'demand' came from previously uninterested financial markets players who were suddenly very keen to capitalize on rising oil prices. They quickly designed ETFs and ETNs to offer their customers, while also playing the futures markets from their prop desks. Today there are at least 35 ETFs and ETNs for crude oil and products and 10 for natural gas.
ICE's release also, very cheekily in my opinion, stated that index funds (ETNs) and ETFs account for an 'immaterial' amount of ICE's revenue. And that these funds typically execute their trades in 'OTC broker markets'. REALLY? Why does no one ever see them in there trading then? Surely OTC swaps cannot be priced in real-time for ETF or ETN calculations. And why, when I do a cursory search on the web for the holdings of these ETFs and ETNs are they ALL FUTURES?? Have a look at the USO ETF - WTI futures only and the volume has averaged 13.6 million contracts per day of late. The OIL ETN? Futures only - 1.7 million contracts per day. DBE ETF? Futures only - 138,256 contracts. Only the index funds holding oil company shares seem to differ. I think a certain energy exchange is telling porkies for a certain energy exchange's own self-interest. A certain energy exchange thinks we are all mugs, clearly.

Stealing Goldman Sachs' Thunder

Much has been made of the Goldman Sachs techie Sergey Aleynikov who allegedly stole some of the code for Goldman's killer algorithms. The media is unclear as to whether Aleynikov took code from proprietary trading algos or from the less-sensitive algos it provides to customers. What is clear is that someone now has access to some of Goldman's 'wicked smart' algos. This is less damaging than the press would lead one to believe. The quants at Goldman Sachs are clever enough to quickly develop a 'sniffer' algo to see whether any of the high frequency trading going on looks familiar. They are also paid enough to work nights until they develop some new killer algos. It only takes a few tweaks and fine-tuning to make them better than before, and probably more undetectable. As far as the idea that the algos will fall into evil hands and decimate the US stock markets goes, well that should be purely fantasy. Goldman Sachs is not the only bank out there with clever quants - there are plenty of eyes on this now and any sign of foul play will be spotted almost immediately. The only real worry is whether the other banks will report it, or just play along and rake in the money as well. High frequency trading takes more than one player.

Paper Lions Need Teeth

In the book "Paper Lion" by George Plimpton the author famously proved that the average guy off the street cannot compete in professional American football. He had his hat handed to him in style. This is what has been happening to the regulators trying to manage energy and commodities speculation. The CFTC said yesterday that it would crack down on speculative trading activity. This is a repeat of what it said in 2008 when the regulator tried - and failed - to re-classify oil hedgers versus speculators as oil prices zoomed to $147.00. One of the major issues has been the CFTC’s method of categorizing commodities and energy futures market participants according to whether they actually have physical market exposure. In other words, if a company buys or sells physical oil, such as crude oil or gasoline, from or to another party then it is classified as ‘commercial’. A bank trading oil futures purely to make money would be considered ‘non-commercial’ or a speculator. These classifications have been in place for some time. Prop shops, hedge funds and bulge bracket banks have squirmed around them and are still trading huge quantities of commodities daily. Over a billion contracts of crude oil futures alone are traded on ICE and NYMEX every day. This is about 1,400 times the amount of actual crude oil produced globally. Speculators have deeper pockets than most hedgers so it is clear that they are trading the lion's share.
What the CFTC needs is teeth, and probably some bodies that understand how these markets actually work. I've said it before - it needs ex-traders. And it needs complex event processing technology to spot trading patterns and subsequent irregularities, especially if (as I am told) 30% of energy futures and options trading is now done by algorithms.

Catch Them if You Can

Bulge bracket banks are getting back to business and re-inventing some of their old tricks in a bid to convince themselves and us that they are whole and healthy again. Banks are slippery fellas, twisting and turning to squirm from the grasp of regulators and spinning like mad to avoid the critical eye of the average investor. The words 'old dogs' and 'new tricks' come to mind, because today's tricks are not new at all. One way they are minting new money is from the ever more popular rebate spinning. Themis' Joe Saluzzi reckons that 60% of equity volume comes from high frequency trading. And these traders are taking advantage of the rebates on offer. Exchanges including NYSE Euronext and Nasdaq, and ECNs such as Turquoise, BATS and Direct Edge are offering higher and higher rebates to attract business. The latest one-upmanship comes from Direct Edge which is now offering $0.0032 per share rebates to customer trading over 100 million shares per day. Now this doesn't sound like much on the surface, but if you actually trade 100m shares with Direct Edge you would get back $320,000 per day. This equates to over $76 million per year in rebates. This is on top of whatever you made doing the actual share trading. This is not chump change even for the bulge bracket. The next old trick is securitisation. Today's FT says Goldman Sachs and Barclays are pooling assets from several clients and turning them into securities that they can sell on. This helps them to lower the capital required to do the business. Wait a minute! This sounds suspiciously like something they did with mortgages that got them into mega-hot water! I call this laughing all the way to the bank.

Risky Business

The mysterious oil trade was perpetrated in London - at 3:00am by one of PVM's brokers. This could be a case of TWI (Trading While Intoxicated), although this time it is BWI - Broking While Intoxicated. The oil business is not know to be teetotal. It could also be something more nefarious than a ticked off broker. Perhaps someone else benefited from the trades. It will all come out in the wash. Meanwhile The Wold Report is doing some investigating as to how this could happen. Was there no risk firewall on PVM's front end trading system? A reliable source tells me that there is no limit to how much a broker can enter into the ICE or Nymex systems on behalf of its clients. That the trades do not go through any kind of limit or P&L system on their way to the exchanges. I am shocked. More soon. Happy 4th of July!

Mysterious Oil Trade Costs Brokerage $10m

On Monday evening at 10:00 ET, 10:00 AM in Singapore, a broker entered an unusually large order for Brent crude on the InterContinentalExchange's electronic trading platform. Initial reports pegged the trade as a buy order for 14,000 lots, or 140m barrels of crude oil. Later reports said it was 'only' 7,000 lots. Either way, it was a gigantic order for out-of-hours trading (the day before only 100 lots traded at that time), which spiked the market by a couple of dollars. The rumour machine, being what it is in the oil markets, blamed a rogue trader and pegged the losses at up to $50m. As it happened,it was a broker. Now, despite the mainstream media referring to brokers as traders, brokers do NOT trade. They execute trades on behalf of a principal. The brokerage that processed the trades - PVM - ended up losing $10m after unwinding the positions.
That a broker in Singapore was able to get into the ICE system and execute trades totaling 7m barrels of oil (with a value of around half a billion dollars) is terrifying. ICE's platform has risk controls in place, but somehow the broker bypassed them. There are only 4 crude oil brokers in PVM's Singapore office, according to its website, so it shouldn't take them long to find out who did it. Why he or she did it - although interesting - is not the point. (In the 1980's PVM's founder Pat Mazoroli famously had his brokers keep telex machines in their bedrooms so they wouldn't miss a deal. That ticked off most of them, but they didn't go around making large rogue trades. Actually, they couldn't have before electronic trading.) The point is that if someone can get past the risk controls of an electronic direct market access platform, those controls need to be tightened. ICE is on the case, so is the FSA.

The Worst of Times?

Today's Financial Times said that, due to the biggest GDP decline in 50 years, the UK has 'never had it so bad'. I beg to differ. When I moved to London in 1979 the streets were piled high with mountains of rubbish due to the dustmen's strike. The air was filthy with coal dust and diesel particulates. Every other shopfront was empty or boarded up along the King's Road, where I rode through on the bus to and from work. Fewer than 40% of homes had central heating (I got frostbite for the first time on my feet from walking around in a home without central heating - me, a girl from Maine!) Only about half of all households had phones, and the ones that they did have rarely worked. In my first real job at Platt's we often had to dial a number up to 10 times to get through. More if it was outside the UK. Inflation was at 27% and life expectancy for women was around 76 years, it was merely 70 for men. Today the streets are clean, the shops are still vibrant (even if there are a few that shut down recently). Almost 100% of households have phones, either land lines or mobile. And 96% of homes have central heating. Women live on average 81 years, men 77. Just because some City gents took a bath on their pied-a-terres in Mayfair does not a Depression make. If it gets as bad as it was in 1979, I'll change my opinion.