A hiring frenzy for Eurobond traders

These are heady times for Eurobond traders, caught in a spiral of salary increases sparked by the latest firms to make an assault on the market. But the age-old nostrum of the bond markets, buyer beware, could equally apply to banks on a recruitment spree.

The recruitment merry-go-round for Eurobond traders appears to have spun out of control. Simon Fry, Stefan Ludwig and John Carroll set a new benchmark for Eurobond traders' salaries in November 1994 when they moved from CS First Boston to Nomura for a reputed total of $20 million over three years. Since then the market hasn't looked back.

"Eurobond traders are enjoying a mini Big Bang," says one trader at a Japanese firm. The beginning of the year usually heralds a lull in movements as traders await their bonuses. But the Rose Partnership, a recruitment consultant, had its most profitable quarter ever at the beginning of 1996, largely on the back of the hiring frenzy for Eurobond traders.

Edson Mitchell's arrival at Deutsche Morgan Grenfell from Merrill as head of global fixed income presaged an exodus from the US house to DMG. But Deutsche Morgan Grenfell's tentacles extend way beyond Merrill. The German bank has hired 50 people from Goldman Sachs alone over the past year.

"Until a year ago we had very little turnover of staff on a our trading floor," says Stephen Gallagher, managing director for debt markets at Merrill. All that changed when DMG started its hiring spree. "They approach my traders, ask them what they earn and then offer to double it," says Gallagher. "We won't compete. Unlike the commercial banks, we have a minimum return-on-equity requirement. The firm aims to make a 15% return-on-equity per business."

In the past Deutsche Morgan Grenfell was regarded as a low payer. Not any more. It has hired 200 staff over the past six months and plans to hire another 200. In the process it has pushed up salaries for Eurobond traders to unprecedented levels.

Traders are being offered a basic salary with a bonus of 200%­300% of this amount guaranteed. In 1994 and 1995 traders were being offered 100% guarantees or no guarantee at all. "There's a dearth of good traders, which means the established ones can name their price," says one recruitment consultant. "No new blood has come along in the past two years because most banks cut back on graduate recruitment in 1994."

Typically, there are three or four top traders in each firm who make the bulk of its profits. This creates a two-tier labour market in London. On top, there's a rarefied tier of elite traders commanding salaries of over $750,000 a year; below them is a rump of mediocre traders scraping by on $300,000.

"The same 100 names keep coming up when I set about filling vacancies for Eurobond traders," says the recruitment consultant. "It's a sellers' market for Eurobond traders. Those with two years' experience have been asking for ­ and getting ­ salaries of $600,000. Recently a trader phoned me to tell me he was leaving Salomon; I had six interviews arranged for him within half an hour."

CS First Boston has been gutted of its senior traders, while the firm's strategic incoherence heightens the restlessness among those remaining. The experience of Peter Knoll is a case in point. Knoll, a Eurolira trader known among his peers as Barnie Rubble, moved from Lehman to CS First Boston only months before CS First Boston pulled out of the Eurolira market.

Even the venerable Morgan Stanley has been hit by the frenzied recruitment market for traders. "It's difficult to find good traders and salespeople," says Jim O'Brien, head of Eurobond trading at Morgan Stanley. "I've had traders snatched away with offers to double their compensation." However, with a note of hubris, O'Brien claims that Morgan Stanley does not need to hire traders who can bring investors with them: "Our clients want to do business with Morgan Stanley, not with an individual." For its part, Morgan Stanley will not offer a guarantee unless it recruits a trader mid-year.

Indeed, Morgan Stanley is said to pay its traders at a 20% discount to the going rate, purely because it is Morgan Stanley. "I know that Morgan Stanley will be here in 10 years' time, not like one of these bucket-shop Eurobond houses that have been springing up lately," says one trader at the bank.

But a fatalistic resolve is increasingly evident among trading-desk managers at US firms. "Two years ago we thought that Deutsche Morgan Grenfell would buy one of the smaller US houses, such as Lehman or Salomon Brothers," says one. "But instead they've bought staff. We can't compete with the salaries being offered. Too often lately I've had to take off my manager's hat and let traders depart on amicable terms because I know that they've been made an offer they can't refuse."

Gossip-in-trade

Spreading misinformation about the revenues traders generate might be a wise counter-strategy. The labour market for traders is driven by gossip. Firms often base their judgements on who to hire on reputation rather than performance, because an outsider has no way of knowing how much a trader earns for his current employer.

Relying on inter-dealer brokers for information is misleading, because they can know only what a bank's turnover is, not what its profits are. UBS is said to have poached traders from Wood Gundy who had booked a loss the previous year. Also, a trader's performance must be seen in the context of the firm he works for. A trader who earns $2 million profit at Paribas is probably as good as a trader at Goldman Sachs ­ a more prestigious firm ­ who earns $5 million.

Rising salaries are not the by-product of rising bond-trading revenues at investment banks. Although volumes in the Eurobond secondary market (as measured by Euroclear and Cedel) are at an all-time high, the intensity of competition is beginning to bite into returns. Some 40% of Eurobond staff in London received no bonus last year. For most traders, that is tantamount to receiving a dismissal notice. In 1993 Morgan Stanley made $40 million trading corporate Eurobonds. In 1995 it made nothing.

"Most houses have had two years of below-budget profits, using 1993 as a benchmark," says Fred Orleans, head of Eurobond trading at Lehman. These sentiments are echoed round the City. "It's as difficult to make $10 million dollars as it was 10 years ago," says Simon Meadows, head of Eurobond trading at CS First Boston. But remuneration has remained at 1993 levels, despite the falling profitability.

Over the past two years Salomon Brothers, under duress from Warren Buffett, its leading shareholder, sought to cut the bonuses it awards to traders. But the policy was abandoned because employees were being lured away by higher pay offers from rival firms.

Much of the excess competition in the secondary bond market stems from the growing aggressiveness of European commercial banks such as Deutsche Morgan Grenfell and SBC Warburg in the primary market.

The big US investment banks all complain about the distorting effects of commercial banks hurling money at the primary market. "Commercial banks are in the top 10 or 15 of the new-issue league tables because they've been willing to pay for their presence," says the head of Eurobond trading at one US firm. "While the American banks are there are on merit, commercial banks got there by buying arbitrage issues from [borrowers such as] German Landesbanks which want to hit their borrowing targets." Deutsche Morgan Grenfell, SBC Warburg, UBS, ABN Amro, HSBC and BZW are all cited as culprits. "They'll book a million-dollar loss by launching an issue at
5-10 basis points off what most would be prepared to pay, just to push their name up the league table," says the trading chief at the US firm.

Says Gallagher at Merrill: "Buying market share seems to be the way forward. But only high-quality primary business ­ and by this I mean doing business at the right price ­ breeds the same in the secondary market. Our trading desk is a separate profit centre. Deutsche Morgan Grenfell and SBC Warburg run their businesses on a different basis." Gallagher believes that some commercial banks provide a negative budget for their syndicate and trading desks, viewing them as a loss leader.

Indirect benefits

Origination managers are under pressure to win deals, many of which will be dumped on brokers via the secondary desk. "Being the best house in new issues just means building up more inventories than any other," says Ronnie Dicks, a managing director at PaineWebber. So, an aggressively priced issue can be bad news for the lead manager's trading desk.

Many firms don't expect their traders to be much more than a support for the primary desk. "Only five or six firms expect to make any money from Eurobond trading," says Sion Kearsey, head of Eurobond trading at Goldman Sachs. There are, however, indirect benefits that may be reaped from secondary trading through information-gathering and the ability to place issues in the market at tighter spreads.

The US investment banks are keen to stress their different approach to bond trading. "The key difference to us is the lack of a risk culture at the commercials when trading with their own capital," says the head of Eurobond trading at one US firm. "Our strength is our appetite for risk." The inference is that the men in the trenches at the commercial banks may have changed, but the generals back at base are as out of touch as ever.

Without a hint of irony, the US firms also point to the disruptive influence of the pursuit of money as the common denominator among new workmates. "When the unifying force among new recruits is money, problems ensue," says Orleans at Lehman. "Individuals pursuing their own agendas create a strategic myopia. Global banking requires the coordination of various interests. A global bond will be traded in three centres and possibly out of two P&Ls. And when a trader knows that one of his colleagues is being paid three times as much as him, it creates tensions."

Cheaper option

The success of Deutsche Morgan Grenfell and SBC Warburg proves that it is possible to build up a successful trading operation in a fairly short time. The standard bulge-bracket rhetoric that customer relations in the secondary market can be established only one trade at a time seems hollow. Deutsche Morgan Grenfell is making inroads into the business by poaching what it regards as the cream of Eurobond traders. Deutsche Morgan Grenfell has gutted Merrill's talent. "[Edson] Mitchell has gone for the best," says Dicks of PaineWebber. "He knows who he wants and he wants them quickly."

When a bank ploughs so much money into recruitment its seems inevitable that it will hire too many staff and pay them too much money. But having weighed up the cost of this strategy against the cost of buying a bank, Deutsche Morgan Grenfell concluded that it was cheaper. And few would deny that the bank has come a long way in a short space of time. One trader at Goldman Sachs who worked at Deutsche Morgan Grenfell for two years winces when he recounts his experience there. "The bank was a joke when I was there," he says. "It was an also-ran, riddled with fiefdoms."

"We've been the sleeping giant of the Eurobond sector," says David Campbell, co-head of fixed-income at Deutsche Morgan Grenfell. "All we are doing is unleashing our potential." Campbell rejects any suggestion that the bank is paying above-market rates to traders. Indeed, he claims that overall staff costs have fallen. "The key change at the bank has been an internal redistribution of resources," he says. Last year, for example, it integrated its asset-swap business (having lost the cream of its talent to WestLB) with its Eurobond market-making operation, bringing it into line with its main competitors.

SBC Warburg has adopted a more cautious recruitment strategy, improving the quality of its staff rather than expanding it. However, it too is prepared to buy. "We hired 6,000 people when we bought SBC Warburg," says Stephen West, managing director at SBC Warburg for international bond trading and sales.

Degrees of excess

The label of "commercial bank" is an anachronism believes West. He prefers to call them capital-based banks.

"The distinction between investment and commercial banks is no longer valid," he says. "SBC Warburg is bigger and better capitalized than any of the US houses." Unlike CS First Boston or Deutsche Morgan Grenfell, SBc Warburg has put traders on its board ­ six of them in total.

West is dismissive of the sniping of US banks: "We see the Eurobond market as another area in which we can make a return on our capital, which we can raise more cheaply than any of the US houses." US investment banks have exported domestically honed skills to the Eurobond market, and to this West attributes their traditional dominance. But times have changed. "On the Tuesday before Easter I was chatting to a trader at Lehman who said they'd had a quiet day, having written about 30 tickets in dollars," says a Eurodollar trader at SBC Warburg. "We had written over 500 that day."

Jostling on the periphery of the market are Japanese firms such as Nomura. The Japanese have made proprietary trading their first objective, with development of a customer base coming a distant second. They have strong distribution channels at home but pose little threat to established houses in dollar or Deutschmark markets.

However, there is growing pool of traders who demand a percentage of any profits they make, a claim that many Japanese houses are willing to meet. Sumitomo, for example, is offering a percentage deal as well as a guarantee, which leaves no downside risk but unlimited potential upside returns for the trader. "Rather than seeking to build a long-term business, these houses are using their capital to punt on the Eurobond market," says one former trader at a Japanese house. At Tokai, for example 98% of revenue comes from risk-taking, compared with 20% at Lehman. "Tokai is running a hedge fund, not a secondary trading desk," says the trader. "They're not looking to develop business that will generate an annuity stream."

By contrast, Deutsche Morgan Grenfell seems to have made a long-term decision to increase the salaries it pays to its traders. "It doesn't matter that Deutsche Morgan Grenfell is paying so much to its traders, if the whole is greater than the sum of the parts," says the head of Eurobond trading at a rival firm. "It's building a strong team of traders, and at the same time sapping talent from its rivals."

But whether or not Deutsche Morgan Grenfell is paying its traders too much remains a moot point. "We're all paid too much," says one trader. "It's all a matter of degree";

More maths, less machismo

Gone are the days when the stereotypical foul-mouthed and filthy-rich bond trader would guzzle five pints of lager at lunchtime and sober up in time to catch the 5:15 train home from Waterloo.

Tight margins have tempered arrogance, and the decline of head-to-head (interbank) trading affords less of an opportunity for ritualistic bragging. "Traders have to put in the hours now because the competition is so much stiffer," says veteran trader Ronnie Dicks, a managing director at PaineWebber. "In the past a trader could just trade his book. But of late they've been besieged by customers who want to see research."

So what makes the 1990s' trader better than average? "Good traders are product managers," says Dicks. "They sell to salesman. A trader can't survive without airtime from salespeople. Lately, I've even seen traders going for a drink after work with salesmen."

But the demeanour of the trader depends on the strategy of his employer. "At [Japanese bank] Tokai, because the trading is mostly proprietary, a trader can have the interpersonal skills of a slug and just sit in the corner and make money," says one former employee of the firm. "But at one of the top houses, traders have to be able to sell to salespeople and sometimes even meet customers."

One of the traders interviewed for this article points at the two computers on his desk and exclaims: "I can't use these damn things, but I don't need to because I have gut instincts." Sadly, these sentiments may mark the death gasp of a dinosaur. The demands placed on traders have risen as banks have consolidated their Eurobond operations.

"I've been trading sterling, dollars and Ecu," says a Eurobond trader at CS First Boston. "So I had to master complex spreadsheet packages quickly."

Analytical skills

The Cockney barrow boy with little formal education but a head for figures is a thing of the past. "My traders all have degrees," says the head of Eurobond trading at one US firm. "Some of them can even work out the yield on a bond."

The analytical skills demanded of traders have grown immeasurably. "Credit risk is becoming more important in Europe as people move away from equities," says Sion Kearsey, head of Eurobond trading at Goldman Sachs. Rival firms strike a similar note. "My main concern when interviewing traders is how well they understand credit," says Jim O'Brien, head of Eurobond trading at Morgan Stanley.

When the Eurobond market took off in the 1980s, the traders who made the most money were expert at the cut and thrust of head-to-head trading. "At Salomon in the 1980s there was head-to-head trading in every market," says Simon Meadows, head of Eurobond trading at CS First Boston and a former Salomon trader. In 1996, however, most houses will make markets only in lira or French francs. "We thought we had to make markets," adds Meadows. "But all we were doing was creating a false liquidity. Investors don't call traders any more and say 'make me a market'. They call brokers and say 'what have you got'."

In the past, firms with little distributive capacity and a small capital base could make markets against the big US houses. But as the market in dollars, Deutschmarks and sterling grew it became apparent that head-to-head trading wasn't needed for liquidity. In 1996 most transactions go through brokers.

The Eurobond market has polarized into specialist and niche markets over the past three years and even the high-volume business requires fewer traders. CS First Boston has seen the number of its Eurodollar traders fall from nine to three, while the number at Merrill Lynch has fallen from 12 to three. "When I look back I can't see what all of those 12 guys were doing," says one trader at Merrill.