Michael LewisRebecca Jackson of the PRA has spoken on the growing importance of Principal Trading Firms, and the opportunities they create for banks. She said banks have reported prime brokerage balances to be at new peak levels, and that the regulators are closely focussed on what might happen if the bubble bursts. She spoke of:
- technological advances, not only in quantum computing and Generative AI but also in infrastructure and other hardware capabilities;
- a changing market landscape, with NBFIs moving into spaces vacated by banks, and Principal Trading firms becoming established as liquidity providers in many vanilla products – effectively moving the proprietary trading risk from banks to non-banks and putting at risk the capital of those firms’ shareholders and founders, rather than depositors’ interests;
- the fact that Principal Trading Firms may now be direct competitors of banks in some market segments, such as FX and credit, while in other areas, like cash equities and equity ETFs they have largely replaced banks. But, these firms need leverage from banks to operate their strategies;
- the counterparty risks that intraday trading exposures create;
- the differences between pre- and post-trade controls;
- the resulting possibilities of a bank pushing the “kill switch” on orders – but that Principal Trading Firms may still access markets outside the servicing bank guarantee – and the short but crucial delays that may occur when banks notice the issue but have to contact the firm to half order flows – this still puts banks at risk and at the need to pay out and then try to recover from the Principal Trading firm; and
- what banks should do – specifically have sound systems and operational capabilities to evolve with the Principal Traders’ business, get their client onboarding and due diligence right and that boards and risk management committees must be inquisitive and aware of the risks from daylight exposures to Principal Trading Firm clients.