Computers and Bloomberg terminals dominate trading floors, but the human element remains a crucial feature of transacting across derivatives and other parts of the global financial system.
This is no better illustrated than by the presence of so-called “voice brokers” who act as middle men for banks trading swaps and other fixed income securities in financial centers that link Asia, Europe and the US.
Voice brokers at firms such as Icap, BGC, Tullett Prebon, Tradition and GFI pool prices from banks and transact in the so-called “interdealer” market. This is the private arena where only banks trade with each other as they offset positions they have with clients such as hedge funds , money managers and corporations.
Brokers relay prices to traders at banks via telephones and squawk boxes and also use screens to provide a guide of where swaps should trade. These pools of prices extend across time zones, with brokers in Tokyo, Hong Kong, Singapore and London helping banks trade US dollar-denominated swaps before and once New York is open for business.
Trading short term swaps based on expectations of where the London interbank offered rate, or Libor, the primary floating interest rate benchmark, will be set at 11am in London for example, links dollar traders from Asia to London.
The current focus of regulators on the possible manipulation of this pricing benchmark for swaps and many types of loans has shone a light on the global nature of trading and the links between voice brokers and traders.
Enforcement agencies in the US, Canada, Europe and Japanare investigating whether employees at leading US and European banks colluded to influence where Libor and other key benchmark rates were set, in some cases to profit on interest-rate derivatives linked to the rates.
The inquiry is examining whether groups of traders conspired with brokers to influence banks’ rate submissions for the London rate for yen , known as yen Libor, and the Tokyo interbank offered rate, or Tibor, according to regulatory disclosures and people familiar with the case.
In recent months, UBS has suspended some of its most senior traders in Zurich in connection with the investigation. More than a dozen other employees at banks including Citigroup , Royal Bank of Scotland , JPMorgan Chase and Deutsche Bank have been fired, suspended or placed on leave.
Icap has suspended one employee and put two more on leave in the past six weeks, while regulators have also requested information from Tullett and RP Martin, another interdealer broker.
In the no-holds barred world of trading over-the-counter derivatives in the interbank market, traders and brokers view themselves as combatants in a professional market, where you lose one day, but can win the next.
But with about $350 trillion of financial products influenced by the daily setting of Libor, that includes mortgages, car and school loans, it means any possible fixing of Libor is no longer a case of just one trader hurting another and earning bragging rights. The possible manipulation of Liborhas ramifications for the broader economy, hence the keen interest of regulators in this matter.
“When you start trying to collude or price fix a benchmark that affects mortgage rates, and the cost of certain car and school loans, it behoves regulators to take a very hard look,” says James Cawley, chief executive at Javelin Capital Markets which operates a screen-based trading system for swaps.
Many in the industry describe the interdealer market as a cosy club of select banks and brokers, who play by their own rules, fashioned since the early 1970s when the collapse of fixed currencies ushered an era of volatile exchange ratesthat required a middle man to help banks trade.
The pooling of prices and possible trading interest from various banks provides a voice broker with a unique position in a market where information is a highly prized commodity.
In effect a voice broker clearly sees where banks want to buy and sell and at what price. In theory the broker has a clear window into the market, whereas a trader’s view is blurred as they do not know what their rivals are doing.
In practice, however a voice broker, who relies upon being paid a commission from a bank, faces a constant dilemma. Brokers generally cover a number of traders at banks, but among all these “lines” one bank is usually their significant account.
That makes the trader at that bank the recipient of the “first call” from a voice broker.
Under such a relationship-based model, brokers and traders are engaged in a system where they stand to mutually benefit. For example, when a very competitive price enters the market, a voice broker will tell their best account the price before they tell their other accounts.
Such a tiered system suits the traders at top banks, who pay for information and service. In markets such as interest rate swaps, a small number of five to eight banks dominate.
For the broker, rewarding their best account with prized information and good prices only cements their relationship and in turn pads their bank account.
Such relationships mean that when a trader calls up their broker for a view of, say, where 10-year interest rate swaps are trading, they are quietly told what other banks are interested in the sector. Prices, trading intentions and potential sizes of trades are relayed by the broker to their best account.
In recent years, voice brokers in the US have fallen foul of the authorities.
In 2009, the Financial Industry Regulatory Authority fined Icap $2.8m to settle claims that a former broker at the firm improperly tried to influence fees on credit-default swaps . Then in 2010, Finra imposed $4.3 million in fines against five brokerage firms led by Phoenix Derivatives Group for improper communications about customers’ proposed brokerage rate reductions in CDS market.
In spite of these obvious shortcomings of the voice broker model, it continues to flourish.
Over the past decade, electronic trading has made inroads into the voice broker world, but only in the most commoditized products such as spot currencies, benchmark issues of government bondsand derivative indices.
The industry is reluctant to fully automate OTC trading because it would result in a more open and transparent market and erode the informational advantages of the big dealers. Smaller banks have little choice but to abide by the rules.
While the slippery intersection of OTC trading where traders and brokers meet is under attack from regulators who are writing new rules in the wake of the financial crisis, the industry has spent considerable time and money lobbying against tough restrictions that threaten their cosy world.
Indeed, proposed new rules under the Dodd Frank Actin the US will introduce new trading venues, known as Swap Execution Facilities, or Sefs. These will allow voice brokers to complement screen-based trading, a hybrid system that maintains the current architecture of bank-to-bank trading.
But the current focus of regulators on the possible manipulation of Libor may well stymie the efforts of banks and brokers to weaken the strictures of Dodd Frank. Moreover if there are legitimate questions as to how Libor is set, then the focus may turn to how banks set the daily fixings of interest rate swaps via broker screens.