Three powerful and transforming currents swirling through wholesale financial services - banks' increased appetite for proprietary trading, the growth of hedge funds and the trend to outsourcing - flowed together at a compelling presentation by Deutsche Bank at Euromoney's annual forex forum at the London Hilton last month.
Deutsche Bank director Steffen Orben described how the bank allocates capital to what it calls a non-franchise trading group. Instead of employing large numbers of its own proprietary traders, Deutsche sees a portfolio benefit in allocating credit lines to hedge fund managers and allowing them to trade the markets on its behalf.
There is a clear financial benefit in doing this. Deutsche has to pay these hedge fund managers a management fee and a share of its profits, but it would otherwise have to pay in-house traders generous salary and bonuses. If external hedge fund managers stop performing well - or if better ones appear - the bank can simply withdraw its lines rather than bear the costs of making highly paid employees redundant.
The bank also has the opportunity to construct an ideal portfolio of proprietary trading styles across markets. It may have very good in-house traders in certain disciplines and would not look to double up its exposures by entering arrangements with hedge funds pursuing similar styles.