Are The Lights Going Out In Barclays' Investment Bank?

Barclays acquired the investment banking business of Lehman Brothers in September 2008 (Photo credit: Wikipedia)

A few weeks ago, following awful trading results, much of Barclays' FICC business was consigned to the outer darkness - placed in Barclays' internal 'bad bank' for eventual sale or wind-up. Barclays' investment bank was to be reduced to a customer service business around an equities trading core - the former Lehman Brothers equities business.

But now that equities trading core has itself been dealt a major blow. The New York Attorney General has filed a lawsuit against Barclays for misleading clients regarding the presence and activities of HFT traders in its so-called 'dark pool', Barclays LX.

Dark pools are off-exchange trading operations run by banks to enable their institutional clients to trade large blocks of shares without signalling price shifts to the market. As large share transactions can distort market prices, this is not such a bad idea. But the problem is the fact that these pools are run by banks. And what is good for an institutional client may not be so good for the bank that is operating the dark pool. It is perhaps no surprise, therefore, that a bank has been accused of lying to clients about the nature of trading in its pool.

The NY Attorney General's lawsuit says Barclays claimed it had safeguards in place to protect against 'predatory' high frequency traders (HFT),w hen it not only had no such safeguards in place but was actively encouraging HFT. It did so in order to increase its market share and to maintain liquidity in the pool. It also sent a 'disproportionately large percentage' of its own client trades to Barclays LX, thereby exposing its clients to HFT activities without their knowledge and to their detriment. The FT reports the NY Attorney General's colorful description of Barclays' activities: they were 'telling investors they were diving into safe waters', when in reality 'Barclays' dark pool was full of predators....there at Barclays' invitation'.

It is alleged that Barclays told institutional clients that there were no HFT traders in the dark pool, whereas in fact the largest trader in the pool - Tradebot - is a market leading HFT trader whose activities Barclays themselves have called 'toxic'. HFT traders usually operate in regulated exchanges, where they make money by exploiting the split-second timing differences between a share trade and its effect on the market price. Institutional investors use dark pools partly to avoid the attentions of these traders. But Barclays, as the operator of the dark pool, would benefit from their presence.

No-one is suggesting that Barclays had no right to allow HFT traders into its dark pool. Dark pools are opaque, unregulated and subject to the whims of their owners. Barclays could let in whomever they pleased. The NY Attorney General's lawsuit is concerned with whether, having let HFT traders in, Barclays then deliberately misled institutional clients about their presence and activities.

Barclays will no doubt try to settle this lawsuit out of court. But the US regulatory environment is getting tougher: Credit Suisse recently pleaded guilty to conspiracy to evade tax, and BNP Paribas has also been under pressure to plead guilty to sanctions-breaking. It may be that the NY Attorney General will refuse to enter into a plea bargain. In which case Barclays may find itself joining the growing number of European banks who have been convicted of felonies in US courts.

Some may argue that the motivation of the NY Attorney General is political. He is up for re-election soon, and successful prosecution of a major British bank would no doubt improve his chances. And it does seem as if European banks are disproportionately targeted by American regulators. American banks are hardly whiter-than-white, but at present they are not in the spotlight. It would be diplomatically helpful if a US regulator could be seen to pursue an American bank. Though that does not mean that European banks should be let off.

But it really does not matter whether the NY Attorney General's lawsuit is either fair or successful. The lawsuit has already done significant damage to Barclays' reputation. Large institutional investors are not impressed: some have already withdrawn from Barclays' dark pool, and others seem likely to follow. If enough withdraw, Barclays may be forced to close it completely. The lights are going out in Barclays' dark pool.

In fact the lights may be going out in Barclays' investment bank. This is its third lawsuit in a year, the other two being its fine from the UK's FCA for fixing the gold price, and FERC's accusation that it rigged US energy prices. If this lawsuit is successful, there will no doubt be a very substantial fine and possibly other sanctions too. But perhaps more importantly, it will open the door to compensation claims of unknown size and scale from institutional investors. Additionally, Barclays Group is still under investigation by UK authorities for fraud concerning its rescue in 2008 by Qatari investors. Coming on top of the collapse of FICC, the dark pool disaster may be just too much.

But these problems call into question the competence of the CEO of Barclays Group, Antony Jenkins. Jenkins' experience is entirely in retail and corporate banking. Two of the three lawsuits affecting the investment bank - including the latest one - are for things that have been going on since Jenkins took over. His predecessor Bob Diamond also presided over nefarious practices in the investment bank, though he lost his job as a result. But Diamond could hardly be accused of not understanding the business. Jenkins can. Is it really appropriate for the CEO of a universal bank to have no background or experience at all in investment banking? How can he avoid having the wool pulled over his eyes by knowledgeable and determined investment bank managers?

It seems unlikely that Barclays will be the only dark pool operator to attract the attention of regulators. Indeed, the share price of the other two big players - UBS and Credit Suisse - also dropped yesterday, suggesting that investors think they will also be affected in due course. Tim Worstall argues that whatever was going on in Barclays LX, it wasn't out of line with other providers. Perhaps all the dark pool operators are misleading clients. Perhaps lit exchanges are too. Or perhaps this is indeed all politics.

This raises further questions about the behavior of regulators themselves. Since the crisis, the principal objective of new regulation in capital markets has been to increase transparency. Opaque practices such as OTC derivatives trading are being migrated to regulated exchanges. So why have regulators permitted equities trading, which has been a generally transparent and well-regulated business, to become not only more opaque, but subject to conflicts of interest? Why has the behavior of banks towards their institutional clients, who manage the savings of millions of ordinary people, been allowed to slip beneath the regulatory radar?

Indeed, if dark pool trading is so opaque, and the banks that manage dark pools are unable to handle the internal conflicts of interest that they create, should dark pools exist at all? Their very existence seems contrary to the spirit of openness and honesty that we wish to see at the heart of finance. Perhaps, as Gillian Tett suggests, they should be closed down.

But as usual, it's not that simple. There is little doubt that if dark pools were closed down, those who wish to operate in the shadows would find other ways of doing so. And therein lies the real problem. Until those who work in banks and markets, and those who use the services that banks and markets provide, agree to change their ways, any attempt to close down or regulate shady operations simply results in others springing up. Jenkins is attempting to change the culture of Barclays, so far - it seems - with little success. But if transparency and honesty are to replace opacity and deceit as the normal way of doing things, culture change is needed across the entire financial industry.

Lokasi:

Share :