Monday, January 28, 2013

Ex-compliance officer makes case for banks providing transparency

In a must read interview on the Guardian, an ex-compliance officer talks about regulators, high-frequency trading and transparency.

His view of the impact of transparency on banks is
What's more, you cannot have a banking environment that is risk free, gives high returns while being highly transparent. That's logically impossible. If you're transparent in what you're doing then others will see it and get in on the action driving down returns.
And why is it necessary that banks generate high returns?  Isn't a low risk banking environment that is highly transparent preferable from the perspective of society?

His view on the fundamental reason that regulators are ineffective

My impression was that regulators were not always alive to how things work in practice. 
The ones I dealt with were often economists, essentially philosophers who had learned to build models. 
Why understand how things actually work in practice when you can just make assumptions to plug into models?  A classic example of this is the bank stress tests.  Is there any surprise that the banks can pass stress tests for capital adequacy and then need to be nationalized shortly thereafter.

Finally, he offers his perspective on high frequency trading
The effect of HFT on the trading floor is fascinating. You can't see the HFT programme, as it is embedded in the computers. So you notice it negatively, when traders complain because something isn't working. And you notice it when you're watching the order book on a screen, and you see movement when the programme buys or sells.
It's when there's a panic that you really realise just how strange and evanescent these programmes are. How do we access them? In the last resort people can actually rip out the cable from the computer. I've seen that happen, but it seems ridiculously primitive in such technological environments. 
No human being could ever do what computers now do with high frequency trading. No human being can see what HFT does. We can only see it afterwards, when it already has made its impact. 
This raises important questions for regulators. HFT is very difficult to corset, to manage. Regulators will probably never have the manpower to monitor all the data, to follow all transactions. So a significant portion is delegated to innovative technology. Many people I have interviewed are genuinely concerned over this.
Perhaps rather than trying to monitor high frequency trading, the regulators should ban it until such time as they are actually capable of monitoring it and making sure that its impact on the financial markets is positive.

By letting high frequency trading continue right now, the financial regulators are effectively gambling with the stability of the capital markets and the financial system.  A gamble that doesn't appear prudent to your humble blogger.

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