Macaskill on markets: New rules for the trading road


Jon Macaskill
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The conviction of former HSBC trader Mark Johnson for front-running a customer FX order could transform the way dealers hedge client trades – and how they communicate with each other.


In October, Johnson was found guilty by a New York jury of nine out of 10 charges of fraud and conspiracy relating to a $3.5 billion foreign exchange transaction handled by HSBC for its client Cairn Energy.

The offending dealing took place in December 2011 when Johnson was the London-based global head of FX cash trading for HSBC, but he was not arrested until last July, when he was in New York to take up a new role with the bank.

The first lesson for any trader concerned about the legitimacy of current or historical deals that profit from customer orders may be to stay clear of the US.

There is irony in the emergence of the US as the arbiter of what is permissible in the global wholesale financial markets just as president Donald Trump challenges existing international agreements in the name of an ‘America first’ policy.

But that irony may be lost on Johnson, as he mounts a legal appeal against a conviction that could bring a prison sentence of up to 20 years.

The fact that Johnson directed trades for a European bank as it converted funds on behalf of a British client from the sale of an Indian subsidiary had little bearing with a New York jury that seems to have been swayed chiefly by the evidence of taped phone calls.

Jurors heard Johnson say: “I think we got away with it” in one call when he was discussing the effect of HSBC’s own trading on the dollar/sterling exchange rate obtained by Cairn for its order. The tape of Johnson saying: “Oh, f***ing Christmas” when he was told that Cairn wanted to go ahead with its entire $3.5 billion trade despite adverse moves in the exchange rate also probably helped US prosecutors to obtain their conviction.

The second lesson for traders looking to maximize the margin from customer transactions is therefore to keep recorded communications about the details of deals to a minimum.

The dangers of unguarded exchanges about profit margins and real price points in fixed income trades are taking a surprisingly long time to sink in with dealers.

Taped evidence

Johnson’s conviction and a comparable recent guilty verdict in a case against a former Nomura mortgage bond trader in Connecticut both resulted from the impact of taped evidence. This should finally convince traders that loose lips can sink dealing ships, to adapt a phrase originated in the US during World War II.

Recorded communications include online messaging and emails as well as phone calls made from dealing desks. So, how to communicate effectively with your trading peers when a complex hedge or other customer order is being handled? 

Encrypted communications links can be set up nowadays, but that would be a risky approach to take now that dealing rooms are finally subject to a degree of genuine monitoring by compliance staff hired after banks were forced to pay multiple billions of dollars in fines for market malpractice.

Video links conducted via meeting rooms away from dealing floors might offer a degree of comfort, but this has to be viewed as something of a grey area. Video evidence has yet to feature in trials of traders, but many dealers once thought (wrongly) that instant messaging on systems such as Bloomberg offered anonymity compared with emails or taped phone calls, only to be disabused of the fact when confronted with evidence by investigators.

That leaves face-to-face meetings as the only safe option for a frank discussion of how to milk a client trade for the maximum profit. A recent trend towards adding informal meeting areas on the fringes of bank dealing rooms should help facilitate this form of communication. It could also contribute to the further balkanization of banking, however, as it will present hurdles to coordinating trades between dealing hubs such as London and New York.

Brexit could add a further complication as it brings unwanted geographical diversity to the trading function for many banks within Europe. Most firms will try to maintain cohesive trading operations in London as far as possible, but some dealers will inevitably have to accompany sales staff to post-Brexit hubs within the European Union.

Bank of America reportedly considered shifting some of its fixed income trading from London to Paris while equities dealers made a move to Frankfurt, although the reports were unconfirmed and may simply have reflected the traditional rivalry between debt and stock trading heads at banks.

A split of this type could be a recipe for inefficiency to parallel the European Parliament’s notoriously wasteful travels between Brussels and Strasbourg, but it would at least also reduce the potential for illicit leaks of client information between different divisions. 

Client trades

The bigger question for banks that employ highly paid trading staff is the extent to which restrictions on creative attempts to profit from handling client trades will constrain revenues in the future, especially in the fixed income and currency markets where bid-offer spreads rather than fees generate profit. 

When Johnson was arrested last year, Euromoney warned that a crackdown on front-running could hasten the death of the principal model for fixed income trading. 

Revenues for the sector have recently stagnated, but with a break from the steady fall that had been seen since the start of 2012.

While total revenues from fixed income, credit and commodities are expected to be down slightly in 2017 compared with 2016, there have been big divergences in performance between different sectors.

Credit and securitization revenues have risen sharply, driven by a recovery in demand for structured products. Credit revenues rose 14% in the first half of 2017 compared with 2016, according to a Coalition index of broad investment bank performance, while securitization revenues jumped by 53%. 

Rates trading – the single biggest fixed income market – started the year strongly but declined in the second quarter and seems likely to be lower for the full year, unless there is an unexpected boost to volatility from fourth-quarter central bank action.

FX trading revenue has weakened as the effect of low volatility is compounded by uncertainty over which market practices will be permissible in the future. 

G10 FX revenue fell by 22% in the first half of 2017 compared with 2016, according to Coalition, and at $3.6 billion was around the lowest level for the period since the firm started to keep records in 2006.

But HSBC seems to be finding that it can make the sector work without the creative trading of its former cash FX head Johnson, for example. The bank’s overall FX revenue, including its large emerging markets franchise, was barely changed in the first half of 2017 compared with 2016, at $1.35 billion. 

It might be a hard grind and duller for the traders, but apparently revenue can be generated without squeezing customer orders too hard.