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    The changing tides of prop trading companies

    Propriety trading or prop companies are those companies who invest for direct market gain rather than earning commissions or fees through their trading activities on behalf of retail or wholesale clients[1].         

     Propriety trading has been historically associated with large banks, however, post GFC and the introduction of the Volcker Rule, the landscape of prop trading companies has dramatically changed in recent years.

    Unlike U.S. and European banks, Australian lenders such as Sydney-based Macquarie can engage freely in trading on their own account. In the U.S., deposit-taking banks are barred from the activity under the 2013 Volcker Rule, a limit that has been a bane for Wall Street.

    [1] https://www.investopedia.com/terms/p/proprietarytrading.asp


    While proprietary trading - or prop trading for short - isn’t banned for European banks, it has become less economic under post-crisis rules.[1]

    Australian banks and financial institutions have gained a competitive advantage in this space, as larger and more well financed companies across the world are facing limitations and exclusions, while Australia does not. 

    One of the main causes of the Global Financial Crisis of 2008, was prop trading companies, such as the majority of large banks (including Morgan Stanley that lost over $9 billion in 2007 on one desk) that went under – some of whom received a government bailout and are running today. 

    How did it all go so wrong and what has changed with prop trading companies?

    Prop desks ran at a significantly higher VaR (value at risk) rate than their market-making peers. VaR measures how much a desk stands to lose if things go wrong. Prop desks were not only holding much larger positions than conventional traders, they were also applying leverage to these positions. To magnify the relatively small margins that their arbitrage strategies generated, prop desks ran VaR figures ten times larger than the market makers who sat beside them.[2]



    There were other prop desks such as JPMorgan that did exceedingly well. The desks purchased AAA-rated collateralised loan obligations when others wouldn’t and sold when the global markets recovered in 2009.

    In short, the prop trading company desks were not only playing with the money of their investors, pension funds, managed funds, but the equity of their firm and the bottom line. When the bottom fell out of the market, the prop trading companies that had the most exposure had positions that were heavily leveraged and didn’t understand what was about to happen with the housing market and mortgage-backed securities were taken down with it.

    Prop trading is considered risky, however, prop trading companies in Australia have prospered in the absence of large international competitors. Only time will tell if the Volcker Rule and global economics will provide this for Australian firms into the future.

    [1] https://www.bloomberg.com/news/articles/2018-11-02/macquarie-lures-prop-traders-to-london-after-rivals-retreated

    [2] https://www.bloomberg.com/news/articles/2018-11-02/macquarie-lures-prop-traders-to-london-after-rivals-retreated

    We welcome you to give our team a call to discuss your investment goals and objectives.

    You can call Walker Capital Australia on +61 2 8076 2210, and we’ll see how we can help you achieve your investment goals.

    Want to read more great information on Proprietary Trading? Check out our Proprietary Trading article: Exploring how Proprietary Trading is different from regular trading