Barometer of Fear

by Alexis; Stenfors

  After I became labelled as a rogue trader, I met people who took a surprisingly positive view of my situation. There were those who argued that the City and Wall Street represented the worst sides of capitalism, and that the whole system ought to be brought to its knees. My actions could therefore be seen as an ‘attack from the inside’, making me into a kind of anti-hero. The fact that I was doing a PhD at SOAS, a university famed for its radical outlook, undoubtedly seemed to confirm that, despite having spent 15 years as a trader, I was ‘one of them’.

  On the other hand, I also encountered those who were fighting tooth and nail to protect capitalism against ‘people like me’. If I agreed to work for them, I would be able to turn my unusual experience into something productive – in poacher-turned-gamekeeper fashion – and thereby pay back my debt to society. After a widely publicised rogue trading scandal at UBS in 2011, I was contacted by one of the Big Four accountancy firms (the Big Four audit 99 per cent of the FTSE 100 companies and are Deloitte, Ernst & Young, KPMG and PwC). The prosecutor had called the rogue trader an ‘accomplished liar’ who ‘played God’ with UBS’s money. The money lost was bad news for UBS, but so was the reputational damage caused by the event. Managers – not only at UBS but also at other banks – had their work cut out in order to convince people (and themselves) that their trading systems and controls were bulletproof. The accountancy firm saw a business opportunity and was wondering whether I would be interested in a job related to trading systems and controls in an American bank. The idea was that I, having exposed defects and weaknesses in one bank, could try to do the same in another, or perhaps even in several other banks by becoming a ‘white hat’. I had to Google the expression, learning that it was another term for a ‘legal hacker’. I found the pitch exciting and absurd in equal measure. If governments could hire skilful hackers, why not banks? Maybe this was the logical next step for traders who had been on the edge (and beyond) of what was considered reasonable and ethical. Employing an ex-hacker or an ex-rogue trader might make perfect sense. However, I had three reservations. First, why would a bank take the risk? The reputational risks seemed way too large should it get out that the bank was so worried about its procedures it was willing to employ a former rogue trader such as myself. The arrangement was too sensitive publicity-wise and would be difficult to keep secret. Second, why would I take the risk? What if something went wrong and I was blamed? With my credibility, who would want to protect me? Third, although it was portrayed to me as ‘a way to pay back my debt to society’, I was not sure how helping another bank would benefit society, and at the same time clear my conscience. I regretted my actions deeply, but this project had nothing to do with the guilt I felt. In the end, these questions did not matter, because the project never got the green light anyway (at least not with me on board). Instead of employing ex-rogue traders as ethical hackers, the accountancy firm told me that the bank in question had instead decided to involve ‘management knowledgeable of the trading environment but not engaged directly in trading’. I should have trusted my initial instinct that the whole idea was absurd. A bank would never voluntarily expose itself to the risk of revealing secrets that related to trading.

  ***

  Secrets are well protected because they are valuable to the bank. Or, put differently, secrets that are exposed can cause harm. Because of the nature of the relationship or contract with the bank, it is therefore complicated for a trader to divulge ‘what the industry does to people working in it’, unless they talk in very broad terms about the industry. The second part of the journalist’s question (‘Do you recognise yourself in characters that feature in Wall Street, American Psycho or Cosmopolis?’) touches upon this indirectly. Wall Street is not only a small section of lower Manhattan or a film directed by Oliver Stone. It is also a metaphor for the speculative activities that take place in dealing rooms on Wall Street, in the City of London, and in other financial centres around the world. The tremendous amount of money that flows through these dealing rooms makes them showrooms for capitalism. Visitors and TV crews might be allowed to catch a glimpse of the action that takes place: seas of flickering computer screens, shouting, celebration, despair, and a few hand gestures by traders indicating that they want to buy or sell something. For an outsider, a dealing room can look a bit like a casino, where dice are rolled and fortunes made and lost every day. Surely, something could be said about this environment and these markets without revealing valuable secrets? The answer is yes. However, this automatically leads to another layer of power and secrecy that is fundamental to how the FX, money and derivatives markets operate. The fact that the international, and often self-regulated, financial markets have become more ‘powerful’ is hardly a controversial statement. We only need to look at the seemingly large, liquid, competitive and efficient markets described in this book (the FX, interest rate and derivatives markets) to find evidence of the phenomenal transformation that has taken place over the last decades. In this context, governments around the world could be seen as having given up power, willingly or unwillingly, to the speculative activity of the players in this global ‘casino’. In simple terms, power has shifted from states to markets, from Main Street to Wall Street, from the 99 per cent to the 1 per cent, and so on. When political economist Susan Strange coined the term ‘casino capitalism’ in 1986,9 she could hardly have foreseen how important and powerful the international financial markets would become.

  Because of this development, it is quite logical that the ‘market’ has come to be regarded as a kind of courtroom in itself, where policy decisions by governments or central banks receive an instant verdict. An ambiguous outcome in an election or a referendum often acts as a strong ‘sell’ signal in the market. Stock markets fall, bond prices tumble and currencies get slaughtered. Such an assessment by the market is not democratic by any means, and the industry shows no compassion or mercy. For instance, following the result of the EU referendum in the UK on 23 June 2016, the pound fell sharply. Although most experts and analysts had warned that Brexit would mean a weaker currency, the victory of the Leave campaign came as a surprise. On the other hand, when a result has been well predicted (most US presidential elections before Trump, for instance), the impact has often been negligible.

  However, the markets have increasingly tended to be seen as objective and fair, precisely because they are perceived to be so immensely competitive. ‘The market is always right,’ many observers claim. ‘The market hates uncertainty,’ others say. But who is this market that is always right? And who is this market that hates uncertainty? This is where the focal point tends to become blurry. The search for answers stops, and instead the conclusion is reached that ‘this is what the market wants’ or ‘this is what the industry prefers’. But when it comes to a real casino in Las Vegas or Monte Carlo, it is also claimed that the house always wins. If we use the casino as an analogy for the market, we should be equally precise. We should look more closely at the house involved in writing the rules and keeping control of the markers, those who decide when the casino opens and shuts, and who is allowed to spin the roulette wheel. In the markets, the house consists of the banks.

  The global markets in foreign exchange and money markets (for both cash and derivatives) are phenomenally large. We know this. But who are these markets? According to Euromoney’s FX and rates surveys,10 87 per cent of the global FX market belongs to the top 15 banks. Thirteen LIBOR panel banks accounted for 96 per cent of this portion. A similar pattern can be seen in the interest rate markets, where the top 15 banks had a total market share of 94 per cent (for both cash and derivatives) in 2012. Eleven LIBOR panel banks accounted for 81 per cent of this portion. When we discuss these markets, or the industry behind these markets, it is impossible not to talk about a very small group of very large banks. In fact, it is impossible not to mention the LIBOR panel banks, which are completely dominant within this small group of banks.

  Banks are corporations, but the banking system is also dif
ferent from other industries. For instance, information asymmetries where one party (the borrower) knows more than the other (the lender) are natural in banking. Banking assets can also be difficult to value, as it is impossible to assess the likelihood of default for every counterparty at every moment in time. Moreover, banks provide transaction and accounting systems. All of these aspects help make the banking sector ‘special’ and allow it to be supervised and regulated differently from other industries. According to Charles Goodhart,11 an economist and former member of the Bank of England Monetary Policy Committee, the central bank automatically emerges as a kind of ‘manager of the club of banks’. The kind of relationship that exists between the central bank and the banks is unique. No other industry is protected by the state to the same degree (through the taxpayers and via the central bank). As banks form the spine of the financial system, it is in the interests of a country’s citizens to know if something is not quite right inside a bank. It would therefore be logical that even though the public might not have the right to gain access to relevant information, the central bank should.

  When I spoke to central bankers during the financial crisis, I got the impression that they did not suspect anything was ‘wrong’ with LIBOR. In the aftermath of the LIBOR scandal, however, the tone had changed. ‘Through all of my experience, what I never contemplated was that there were bankers who would purposely misrepresent facts to banking authorities,’ Alan Greenspan said. ‘You were honour bound to report accurately, and it never entered my mind that, aside from a fringe element, it would be otherwise. I was wrong.’12 Greenspan, who had often been referred to as the world’s most powerful banker, or even one of the most powerful people in the world, was a man you listened to as a trader. The Federal Reserve had a tremendous amount of power, and Greenspan had been the captain of the ship for almost two decades.

  Being what they are, central banks have an interest in participating – at least as an observer – in important matters relating to financial markets and benchmarks they are active in or influenced by. For instance, they are founding members of the Association Cambiste Internationale (ACI), more commonly known as Forex – the leading trade organisation for dealers in foreign exchange and money markets. Central banks also participate in the International Capital Market Association (ICMA), which represents a broad range of capital market interests and is the forum for market conventions and standards within such markets. The International Swaps and Derivatives Association (ISDA) is also an important organisation, more specifically in the derivatives market. Here, central banks tend to be so-called ‘subscriber members’, whereas the market-making banks are ‘primary members’. Sometimes, central banks are required to take a more active role. Through incentives, or various ‘carrots and sticks’, they are able to get the banks to act in a certain way. For instance, central banks have the power to grant bank licences, thereby giving certain financial institutions privileges that are attached to simply being a bank – such as accepting deposits. However, these privileges naturally depend on certain restrictions and conditions, ranging from capital and reserve requirements to rules on governance and reporting. The central bank also decides which banks are allowed to enter into repurchase agreements (‘repos’) with them, which is where banks put up collateral in return for cash, or vice versa. For central banks, repos are a crucial element in order to conduct monetary policy. Doing repos with the central bank can be lucrative for the banks, and the central banks know this.

  A similar logic applies to the power of the central bank, the treasury or debt office to grant ‘primary dealerships’ in the local T-bill, government bond or FX markets. Primary dealers are, in effect, ‘official’ market makers that commit to follow certain rules and regulations that are somewhat stricter than those followed by normal market makers. They might, for instance, be required to provide central banks with some valuable information about the state of the market or to follow stricter rules when it comes to providing liquidity. In return, primary dealers are given certain privileges. A central bank might choose to intervene in the FX markets only through its primary dealers. As an intervention, by definition, is intended to move or support the market price, getting the information first-hand means a slight, but important, informational advantage over other competing banks. One second can mean a lot in the FX markets.

  Once, I was invited to a Christmas party organised by the Bank of Japan for all the primary dealers in the Tokyo FX market. Compared with the lavish parties organised by brokers, such as ICAP, Tullett Prebon or Meitan Tradition, it was a rather dull event, consisting of a huge conference room dotted with small round tables where you could stand and mingle, while being offered wine and canapés. The gaijin gravitated towards one part of the hall, and the locals to the other. Speeches, when serious gentlemen gave serious talks about the Japanese economy and the financial market, were held at a podium. These generally finished with the conclusion that it had been an interesting year, and that next year would be even more interesting. Applause. The party was over in two hours exactly, and, when leaving the building (and, I admit, desperately looking for people who wanted to continue somewhere else), I asked one of my Japanese colleagues why everyone from the market had turned up at the party. ‘Ah,’ he said. ‘In a speech a few years ago, the Governor told the room that if he was in their shoes, he would not go home “long yen”. Since then, nobody dares to miss the party, or forgets to bring a mobile phone.’ My colleague explained that Bank of Japan had effectively given the traders a ‘tip’, by saying that unless they immediately sold the positions they had in yen and bought other currencies instead, the central bank would step in and intervene in the currency markets the following day. It worked. Traders, as soon as they could, scrambled for their mobile phones to call the junior traders who were still back at the office, and told them to sell Japanese yen before everybody else did. I can never be sure whether the central bank had actually given the traders in the room this non-public information. Maybe it was just an urban myth, or maybe ‘if I were in your shoes’ simply meant that the Governor thought the Japanese yen was fundamentally overvalued at the time, and this view corresponded with their economic outlook at the time. It is difficult to say.

  Some years later, and back in London, my manager at the time got a phone call from the Federal Reserve. The caller wanted his opinion on what he thought the market reaction would be if they decided to cut the central bank interest rate at the next meeting by a remarkable 50 basis points, rather than the widely expected 25. After hanging up, my manager explained what had happened and, without hesitation, bought LIBOR-indexed Eurodollar futures contracts that would soar in value should the Federal Reserve decide to take the market by surprise. In this case, the central banker had provided no clues whatsoever about what they were up to. He had, however, revealed something that hardly anyone in the financial market had considered – that they were contemplating 50. The unimaginable turned into a probability. A secret thought or discussion was, perhaps unconsciously, transmitted to traders who immediately tried to profit from it.

  Close relationships with central bankers, whether in foreign exchange or interest rate markets, can give an informational edge. The same goes for primary dealerships in government bonds and T-bills. The ability to participate in auctions or to be a vehicle through which interventions take place is often profitable, but sometimes also loss making. The information, however, is useful. If you cannot profit from it directly, it is still perceived to be valuable, as others not belonging to the club might think you know something they don’t. This enhances your reputation tremendously in the market place. When I was working for HSBC in Stockholm, we were desperate to become primary dealers in government bonds. Being part of the T-bill club was not enough. Some of our sales people even complained that their customers refused to trade with us unless we also joined the bond club. The information they got from the primary dealers was superior to what we had to offer. When we gave them some market colour, it was already old n
ews. So we hired a team of bond traders, applied for primary dealership and got the membership card. It was seen as an investment.

  While being a club member was in itself seen as prestigious, it goes without saying that once you got to sit at the table with the big boys, you wanted the best seat possible. In the Swedish FX market, one route was to do well in the annual primary dealer survey, an assessment by the competing club members on behalf of the central bank. In the questionnaire, you had to assess how professional you thought the others in the club were on a scale of 1 (‘Poor’) to 5 (‘Excellent’). Then, you subjectively ranked each bank from 1 to 10 (there were 11 primary dealers and you could not vote for yourself) according to their expected performance in the forthcoming years. In 2004, I ticked Den Danske Bank for the top spot. They were brilliant. The survey, of course, was supposed to be confidential, but JPMorgan Chase ‘accidentally’ managed to copy in a few interdealer brokers when emailing the reply to the central bank. According to them, we should be last. I had already rated them last, so there was no point in thinking about possible revenge. Even though it felt personal and seemed like a public insult, we managed to win the category for FX swaps that year. That meant being invited to sit next to the Deputy Governor at an exclusive lunch organised for the foreign exchange dealers. Apart from the incident with JPMorgan Chase, however, I genuinely believe that most traders took such surveys seriously and refrained from strategically marking each other down. In any case, central bank surveys were always constructed as if traders were honest and forthcoming people. And as if they were playing a fair game.