Friday, June 25, 2010

The Words "Can" and "Worms" Come to Mind

The U.S. financial regulation reform bill (called 'finreg' for reasons I don't care to know) seems to be all over bar the shouting, which of course began immediately on CNBC on Friday morning. The crux of criticism appears to be that the banks will - GASP - have to retain enough capital to cover their own losses in future. (Have they not heard of Basel II or III?)
The more draconian rules that impact capital markets players - with regards to proprietary trading, hedge funds and swaps trading - were greatly watered down in order to get a deal through. The Volcker Rule was shaved to allow banks to continue to invest in private equity and hedge funds, albeit on a very limited basis. But it is far from its Glass-Steagall roots.
Vanilla over-the-counter derivatives will be required to trade on exchanges and to be cleared, with bespoke OTC having to report central repositories. There are new margin and capital requirements. And banks will only have to spin off some of their riskier derivatives into subsidiary companies, leaving interest-rate and FX swaps in-house. No major surprises.
Which begs the question, was it worth all the trouble? I think it was - and it wasn't.
I like the fact that the big banks, hedge funds and prop trading firms are now aware that they are being watched. The days of free market for all, and damn the torpedoes full speed ahead, are over. The regulators will pick up the ball once the bill is signed into law, and - in theory - will understand how to make the rules stick. (This of course depends upon whether they stop acting like government employees, i.e. not just surfing naughty websites while their pensions mature).
I don't like the fragmentation that spinning off affiliates for swaps and OTC trading will create. Risk managers will have a nightmare trying to gauge risk and maximize capital across not just asset class silos in-house, but across subsidiary companies that are taking large positions.
It could be that the new regulations open up many new cans of worms. I feel certain that the banks and big trading companies are already figuring out how to game the new rules, that is what they do after all. There are always new opportunities to be found with new regulations. At the SIFMA conference a group of analysts discussing the impact of financial regulation on technology mentioned one.
If derivatives are to be more widely traded on exchanges, they will be eligible for high frequency and algorithmic trading. This means the margins will shrink (it is already happening with energy futures, a major oil company tells me), as will profits. Transparency does not come without costs. This means players will have to create more complicated bilateral OTC deals in order to make money. Or move away from the U.S.. My bet is that both will happen.

Thursday, June 24, 2010

SIFMA and the World Cup

I just returned from the Securities Industry and Futures Market Association's Financial Services Technology conference and exhibition in New York City. There were a record number of registrants, a SIFMA rep told me 9,000 people signed up, which was a very good sign (last year was dire - maybe 5,000 I'd guess). The stands were busy, if still more sparse than before the financial crisis, and the parties were packed with Europeans as well as Americans. That is the good news.
The bad news is that on Wednesday, when the U.S. was playing in the World Cup against Algeria and England was playing Slovenia, there were only two or three screens airing the matches. At the Bloomberg stand, one of the sales guys had tracked down a free streaming TV service and had the U.S. match in a tiny corner of the screen. Downstairs in a 'pub' set for a vendor there was an actual TV screen and probably 50 people crammed in around it. I mentioned it to some other vendors who all said that they didn't want to pay the Hilton for internet service at the conference, it was too expensive. And too slow. Therefore nearly everyone had canned demos at their stands.
Now I realize that the SIFMA technology exhibition is mainly attended by swotty geeks (I count myself as one, so please do not take offense). And the U.S. is only just beginning to take notice of football, i.e. soccer. So the fact that not many people were interested in the World Cup is fair enough.
But the fact that the foremost technology exhibition in the world, with big name vendors from IBM to Bank of America, cannot provide even the most basic technology to its exhibitors is not understandable. It is downright ridiculous. (And, by the way, Verizon was exhibiting - hellooo...)Vendors pay a lot of money to exhibit at this conference, and if they want to display the World Cup at their stands or show their clients something live online they should be able to.
So, vendors - take a stand. Tell the Hilton and SIFMA that you are mad as Hell and are not going to take it anymore. Demand connectivity for free (or at least cheap). If SIFMA wants the industry to crawl back to normalcy, it really ought to provide it with the necessary tools.

Wednesday, June 16, 2010

Crisis, Drama then Reform

In the 1980s, insurance company Commercial Union had a very catchy tagline: "We won't make a drama out of a crisis." This phrase could be turned around for the ongoing financial markets disaster, because much drama has been made from this crisis. And out of drama comes reform.
Change comes when big drivers - i.e. crises - force the industry to address its issues. The Enron debacle gave us the Sarbanes Oxley Act, global terrorism and 9/11 spawned Know Your Customer and anti-money laundering initiatives. Now the meltdown of 2008 is about to be rewarded with comprehensive financial regulatory reform. And BP's massive oil spill in the US Gulf is going to be the game-changer for oil drilling regulation (maybe even climate change).
As with most painful events, once the drama fades the will to punish the wrongdoers often weakens. In the run-up to the two financial regulation bills - one from the House and one from the Senate - resolve appeared to be wilting. Unrelenting pressure from an army of lobbyists for the financial services industry seemed to be making progress.
Fierce lobbying seemed to stiffen the resolve of politicians instead. Now as the bills go to a committee to find middle ground, much of what is irking Wall Street may come to pass. The Wall Street Journal reported on Tuesday that many lobbyists are now being turned away, with many being told their bank's views are already well known (imagine that!).
The Volcker Rule, once considered the most over-reaching solution possible by financial institutions, now looks certain to be included. The banks shrugged and turned their drama queen act toward Senator Blanch Lincoln's more draconian derivatives legislation. Although this one is losing momentum, with some softening indicated, it is still likely to be part of the overall package. Proposed regulation of ratings agencies (who practically minted the term 'conflict of interest') seems to be falling off the radar, however.
Whatever regulation gets through will have to be finessed and managed by the SEC and CFTC in the future. This is a task they were not up to previously. But again, perhaps lessons are being learned. According to the Washington Post, the SEC is hiring experts with specialized quantitative skills or have worked on Wall Street, thus will have a better insight of the  markets they regulate.
But as regulators learn, financial institutions learn faster. They gird their loins by hiring better lawyers or even SEC executives. The secretive high frequency trading company Getco hired Elizabeth King from the SEC, she was a key associate in charge of crafting rules for the equity and option markets. Last year Goldman Sachs hired Arthur Levitt Jr., the former chairman of the SEC, to advise the bank on public policy issues. (Although this year Goldman Sachs had to hire legal gun Gregory Craig, President Obama's former legal counsel, to help fight a civil suit brought by the SEC.)
Maybe now that the last financial crisis is on its slow, bumpy way to normalcy and the drama is fading, the regulators can get on with their work and prevent the next crisis. We can only hope that the regulators will have the wherewithal to hire the right experts, buy the right monitoring technology and the power to demand the transparency needed to make sure they know what is going on. Next stop - oil drilling regulation.

Wednesday, June 2, 2010

A Potted History of BP Trading

Joke: Why did the bumblebee fly with his legs crossed? He was looking for a bee pee station!
The first time I heard of BP was when it installed a gas station on the corner near my high school in Bath, Maine. BP was largely unknown in New England in the 1970's. Unlike today.
Fast forward from high school to my first real job in London in 1981, where I was reporting on oil prices for Platt's (a McGraw-Hill company, now under the Standard and Poor's umbrella). I would speak daily to the oil trading offshoot of BP, known as BP Amro. The traders were located in the Hague in Holland, for some reason. They soon moved to London, where the action was. (Albeit to the City - where only dusty financial types lingered. The real action was in the West End where Vitol, Vanol, Marc Rich, etc. worked and played.) From the beginning, I saw that BP traders were different from the rest.  For a start they all seemed to have northern or Scottish accents. (The accent norm in the oil business in London at that time was wide-boy Essex or Kent.) I'm told that is because BP recruited engineers, who were mainly educated at Sheffield University near Manchester. They were more like barroom brawlers than oil traders. In an industry where heavy drinking was practically a requirement, the BP boys put everyone else to shame. There was a pub under their City offices to which most of the trading desk (or bench as they insisted on calling it) would decamp for the afternoon. This was before cellphones, so there were dedicated phone lines behind the bar so that they wouldn't miss a deal. Because underneath the fug of smoke and beer, there were some pretty sharp traders. Maybe it was the northern stubborn streak, but once they had a mind to do a deal they did it. Corners were cut if necessary, and lies were told. But, hey - that was part of the business. My sources tell me that BP's trading desk was and still is the most successful of any oil company. It also had a reputation for being a skinflint. Salaries were pathetic and there were no real bonuses at the time. Then after losing trader upon trader to Phibro or Vitol, BP started to pay its traders properly, and to reward them with decent bonuses. It realized that training someone from college all the way to the trading desk, only to lose them a year later, was perhaps more expensive than rewarding them in relationship to industry standards.
Besides the skinflint reputation, there also a whiff of the bully about the company. The traders often turned violent after bouts of drinking. The BP Curry, a legendary 'lunch' party at the end of the annual Institute of Petroleum Week, would usually end in fisticuffs. Sometimes these even involved journalists, and one of my old reporters got pounded a few times. (He was a stickler for the truth, so perhaps it was not the industry for him.) BP's Chicago trading office still takes 2 hour pub breaks at lunchtime, my sources tell me, something that is rather unusual in the US - even for Brits living here. But the money was piling in, and no one at BP cared too much about what the outside world thought of them.
Then, in 1987 BP's Grangemouth refinery started showing some cracks. A fire was followed days later by a hydrocracker explosion. It was so powerful that, according to a friend who worked there, a farmer on his tractor a mile away was blown into the air - with his tractor. He survived, but two BP fitters did not. Grangemouth continued to deteriorate and in 2000 suffered several incidents including a major catalytic cracker fire, despite continued warnings about possible safety violations from the Health and Safety Executive. A fire at its US Texas City refinery in 2005 killed 15 people. BP was beginning to get a bad rep for safety. Many fines later, the deepwater oil rig in the Gulf blew.
I am not trying to pass judgment on BP. It was and is a fine oil company, and I have many friends who have passed through its doors. I do wonder, though, if in the pursuit of profits perhaps too many corners were cut.