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Msg  26761 of 110512  at  9/2/2015 9:48:38 AM  by


WSJ - Market Bets Abound, but Where Are the Banks?

As Wall Street brims with tales of hedge-fund fortunes made and lost amid recent market gyrations, banks have been stuck on the sidelines, hamstrung by postcrisis rules governing what risks they can take.


Goldman Sachs and its big-bank peers have sharply reduced their market exposure, making them relatively absent from trading in the latest volatility. PHOTO: JUSTIN LANE/EUROPEAN PRESSPHOTO AGENCY

The past two weeks of nearly unprecedented stock-market volatility once would have marked ideal trading conditions at the country’s biggest banks.

That era is over.

As Wall Street brimmed with tales of hedge-fund fortunes made and lost amid the gyrations, the big banks were largely relegated to supporting roles, according to bank executives, traders and other investment professionals.

Hamstrung by new postcrisis rules governing what risks they can take, banks focused on executing trades for clients rather than making their own bets, these people said.

“The banks are not part of the market narrative right now,” said Tom Hearden, a senior trader with Skylands Capital LLC, a Milwaukee-based money-management firm.

Before the financial crisis, most banks would have committed tens of millions of dollars—or more—of their own money daily on trading hunches. Traders would hold on to stocks, bonds and currencies as the market churned—or even purchase more of these investments, providing a useful buffer for the market—confident prices would eventually turn their way.

Those types of wagers—those unhedged by an offsetting trade or lacking a clear purpose for clients—are now largely forbidden.

The banks won’t report trading results until earnings are announced in October, but one senior trader at a large bank said that only about 10% of the firm’s stock trades recently were motivated by taking advantage of market swings. Before the 2008 financial crisis, it was about 50%.

Other bank traders said their firms were never quite as aggressive as that, but agreed they were taking fewer directional bets these days. A former bank executive, who now runs a hedge fund, said many bank traders “are now just glorified order takers.”

This is essentially the way regulators want the new Wall Street to work.

After more than five years of debate and preparation, the so-called Volcker rule took effect in July. The provision, part of the 2010 Dodd-Frank financial-reform law, limits the risks bank traders can take with their firms’ own capital. The provision was made in hopes of protecting firms from big losses in times of stress.

Rather than banks keeping stocks and other assets on their books for lengthy periods, the rule requires firms to unload them quickly or risk having regulators view those holdings as proprietary bets. The rule is expected to have a bigger impact in the bond market but it has affected stockholdings as well, as the past two weeks demonstrated.

“This does help the safety and soundness of the system,” said Glenn Schorr, a banking analyst at Evercore ISI. “But the flip side is that in times of stress there is less liquidity in the market and worse execution.”

At Goldman Sachs Group Inc., the firm’s average daily value at risk—a measure tracking the most the firm says it could stand to lose in one day of trading—for the past five years has ended June at or below where it was in the same period a year earlier. The figure stood at $77 million during the second quarter of 2015, down from $136 million in 2010. The firm had, on average, as much as $28 million at risk in the stock market during the most recent period; in the second quarter of 2010, the same measure was at $61 million.

The drop-off in trading risk is even more pronounced at Goldman’s longtime archrival, Morgan Stanley. That firm’s average daily value at risk has dropped to $54 million during the second quarter of 2015 from $164 million in the same period five years earlier.

More broadly, investment banks and brokerage firms have reduced their holdings of stocks and corporate bonds by as much as 70% to 90% compared with before the financial crisis, according to Jeffrey Kronthal, who was a member of Merrill Lynch’s operating committee until 2006 and now helps run KLS Diversified Asset Management LP, a debt-focused hedge fund that manages nearly $4 billion.

“Wall Street’s role as an intermediary and risk taker has shrunk,” Mr. Kronthal said. “Inventory has to turn over quickly.”

Banks could still incur losses, particularly in a period like the recent one when the market’s overall trajectory was down. But the tumultuous swings of the past two weeks didn’t result in outsize profits or losses as in the past; nor did they evoke anything approaching the frenzies of previous crises—even as the market surged wildly in either direction, according to people familiar with the matter. And the advent of electronic trading on the stock market, where volatility surged last week, has meant banks no longer play as crucial a role as they do in less-liquid debt markets.

At the Federal Reserve’s gathering in Jackson Hole, Wyo., last weekend, officials said the markets generally functioned smoothly despite the spasms of volatility. They said they saw few signs of stress in the markets, whether because of regulatory changes or other factors.

At Goldman, Morgan Stanley, Citigroup Inc., J.P. Morgan Chase & Co. and other banks, many executives are on vacation in late August, and few were called back to pitch in as they would have if their firms had more at stake, those people said.

Before the new rules set in, “you would’ve expected banks to capitalize on the volatility,” said Thomas Maheras, a former senior executive at Citigroup.

Within Goldman, long considered one of Wall Street’s top trading houses, executives said they have found their traders often turning conservative on concern any bigger moves might not only lose money, but also draw scrutiny from compliance officers and regulators. “That psychology has a lot of impact in the way people trade in a volatile period,” according to one person familiar with the firm’s thinking.

Compounding matters is the increasing effort required to justify any trades that approach a gray area with regulators. After the Swiss franc unexpectedly shot up in value in January, for example, traders spent weeks responding to regulators about where banks made and lost money and how they communicated their actions to clients, said one executive at a large U.S. bank.

As banks and brokerage firms do less trading, some observers see opportunity for hedge funds. Funds now have less competition for trade ideas and can step in and buy stocks and corporate bonds when prices surge higher or lower, assuming the role bank traders once embraced to find profits.

“More hedge funds are stepping into the role” vacated by proprietary traders at banks, says Scott Warner, managing director at Paamco, a firm in Irvine, Calif., that invests $9.5 billion in hedge funds.

Mr. Warner says hedge funds last week bought newly weakened shares of companies involved in takeovers, such as Altera Corp.,Charter Communications and Avago Technologies, moves that bank prop traders once took in past periods of market upheaval. Other hedge funds bought loans, junk bonds and other areas that bank traders once focused on, Mr. Warner says.

Some funds say they tried to buy shares more broadly on Monday but couldn’t find enough shares for sale, partly as a result of the wariness of bank traders to play a big part in the market.

“It feels the banks are getting more risk averse and that’s making it hard to trade,” says Gabriel Grego, who runs hedge fund Quintessential Capital Management LLC in New York. Mr. Grego says the cost that brokers have quoted him recently to borrow shares has more than quadrupled, making it harder for him to short stocks that he feels are overpriced.

—Emily Glazer contributed to this article.

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