Modern Investment Banks

“Once upon a time investment bankers were supposed to facilitate capital formation for exciting new businesses. They were trusted advisors looking out for the interests of their investor clients, chaperoning to capital to efficient purposes.” William Banzai

In the past, IBs were run by the bankers who protected clients with equanimity. These firms are now dominated operationally by traders. The trading culture operates faster and more darwinistically. This type of environment has no problem in disadvantaging one client to the benefit of another. And frankly it will in the end disadvantage all clients to serve the firm’s short term interests when need be.

Mind of a Flow Trader

Before the client makes a trade.

1.       The Firm makes a buy recommendation because they believe it and/or

2.       The Trader takes a position in the asset prior to telling clients they believed in it or

3.       The Firm makes a buy recommendation because the Trader senses buy interest, regardless of fundamental opinion.

While the client is placing the order

4.       Trader buys for his prop book because he sees captive client interest (resting orders) underpinning demand and/or

5.       Trader buys alongside the client if he continues to believe in it or

6.       Trader sells existing position to the client for a profit or

7.       Charge a “convenience premium”- Sell it as a market-maker and back-to-back it with another counterparty cheaper.

When the client wants out

8.       Back-to-back an executable order with another market participant or

9.       Take a resting limit/ stop exit for your book

10.    When #9 is executable, take other side if advantageous for your current position or execute in broader market as agent if not.

What keeps a Trader’s predatory behavior in check? Traditionally it was the Bankers which ran the firm like an ongoing concern, Brokers, which were charged with keeping their client’s interests first; and finally regulatory bodies to the extent they actually have oversight.

Traders

Traders are animals, seeking profit above all else. Their only customer is their Firm. Everyone else, including the Firm’s marketers, Brokers, and Bankers, is a counterparty and potential sap. Their job is to kill. They are no different than any well trained Marine in this sense. Their single minded, hyper-focused approach to business shields them from external distractions. It is not their job to worry about clients. Client complaint? Talk to the marketer. Bad fill? Sorry, your customer, your problem. I’m protecting the firm’s balance sheet and generating revenues.


“Mr. Banker, I make the money that puts your ass in that towne car every day. If you like, I would be happy to let you manage my position for me. Do you even know what a Conversion is? Oh, you came from sales, figures.”

Traders operate legally, not necessarily ethically. These days, they are the rock stars of Banks, and are the dominant culture, starting back in the days of the Lehman traders rebellion against their Bankers.

Brokers

If traders at IB firms are animals, Brokers (and their cousins, Marketers) are animal Trainers. They keep traders in check by protecting their clients’ interests. Not easy to do when your clients are traders to begin with. Even harder when you are not an independent broker, but part of a Broker-Dealer operation where your primary, and sometimes sole permitted liquidity provider is the asshole Flow trader down the desk from you, who is constantly trying to find out what your client’s weak point is and gun for it.

Balance your clients’ interests with the fact that some of your own customers see less value in what you do, and simply want to talk to the trader for prices. The best selling tool is a good price for sure, but do these clients even know what will happen to them when they have to get out if they are not protected by a broker?

“Hey Flow trader, you suck and my client is getting better prices across town. And the next time you fuck me on a fill, I’m going to lose this client. And without flow, you are just another day trader asshole.”

Brokers/ Marketers are the rainmakers at the operational end. But these days, the IB culture is a Trader’s culture and a good Broker/Marketer is increasingly undervalued and hard to find. Even more so, those that intend to do right by clients often get punished for it.

Bankers

Bankers run the circus. They keep traders in line making sure the Firm’s clients are protected. They also try to make sure no client is operationally preferred over another in executions. The book is the book, and the price is the price. If a client’s price is violated, then the client is filled.

“Hey Flow Trader, you just burned a client with a fill. Do you know who makes money for this firm? The chair you sit in makes the money here, not you. Because of our reputation and relationships in banking you get deals. Do it again and you’re fired.

A Word about Resting Orders- Central Limit Order Books

Resting orders are information, which is key to maximizing trading book returns. Clients with resting bids at IBs may never get filled as the firms Flow Trader is buying at prices just above them. Orders may trade thru prices and no fill is guaranteed. The factors that the good Flow Trader weighs constantly is what level of disservice will the client tolerate before he leaves vs. how much money can be made on this particular trade. (That is a cynical way of saying, how to balance the short term profit prospects with the long term objectives of the firm as a viable concern.) The Flow Trader’s potential bonus and job security are the tipping factors. Guess which way he will tip with no moderator?

Conclusion

With the morphing of the Banking culture, deals are no longer underwritten in a syndicate. They are just big trades. It is too hard for even a competent Banker or Broker to keep up and know what is in the best interest of the firm, especially when the deal velocity is as fast as it has become, and firm wide books are aggregated for risk management purposes. Something has to give, and it is the client who suffers. Traders have the loudest voice now as they are on the surface the biggest revenue generators.

The question for any financial firm that engages in Flow-trading is: Do you run your firm like a series of sprints, looking to max out profits on each trade and not care so much if a client gets burned, or do you run a Marathon, opting to preserve the relationship and lose a penny to better ensure a stream of nickels in the long term?