It's been 10 years. Ten years ago, BNP Paribas suspended withdrawals and investments in three of its specializing in subprime loans and the European Central Bank made an emergency $112bn loan to banks in Europe. The financial crisis was born.
A decade on, insiders say the job of credit traders at investment banks has changed beyond all recognition. It's not just the elimination of proprietary trading at U.S. banks under the Volcker Rule. It's also the big changes to market dynamics resulting from the central banks' intervention in bond markets. And in particular, it's the role played by the European Central Bank (ECB) with its refinancing operation and €2.3 trillion asset purchase programme (quantitative easing) initiative. If you work in credit trading now, the ECB has changed everything.
Louis Gargour, CIO at credit-focused hedge fund LNG Capital and a former credit trader at J.P. Morgan and Goldman Sachs with 33 years' credit trading experience, says a whole generation of traders have come of age in the artificial market conditions engendered by the ECB. “A lot of the guys in the market now started out in 2009," says Gargour. "They’ve been doing this for one credit cycle and all that time they’ve been buyers with the ECB behind them....What happens when the ECB disappears?"
With the ECB as the "thousand pound gorilla" buying up trillions of euros of bonds in the market, Gargour argues that credit traders' job has been reduced to reading the ECB's publicly available information on its purchasing criteria and ensuring they buy the bonds ECB is targeting in order to sell them to clients who can make a profit: "It's been a free ride."
A former Barclays credit trader, says the ECB's impact has been to create a single "general buyer" which no bank in the market has ever challenged. "Prices rose and yields dropped and here we are. Volatility has fallen as there's always a backstop bid from the ECB... Few credit traders therefore now know what volatile trading is like, or long term sell-offs."
Today's traders are lazy agrees another veteran J.P. Morgan credit trader: "They have an idea what they ECB will buy and they buy that and pass it on. They just trade against whatever the ECB is buying. It's working against an order, which is exactly what we were taught not to do."
Nor is it simply a question of only ever working in a unidirectional market. Veteran traders say the ECB has also deprived the new generation of an ability to short individual bonds. The ex-head of credit trading at one U.S. bank in London says historic hedging practices disappeared once the ECB bought most of the bonds and stopped lending them out to investors for shorting selling purposes. "When investors owned the debt, they were happy to lend it out," he says, "But the ECB just sits on it. If you can't borrow the assets, you can't short them - the old kinds of two way markets have become much harder to make."
“If you want to short a bond, someone has to lend it to you," agrees Gargour. "But now that the ECB’s taken the supply out of the market, no one can lend. Shorting has therefore become more about using proxies than shorting particular securities. You might go short the IG Index or its components, for example.”
In other ways, however, traders say conditions since the crisis have forced today's traders to develop entirely new skills. With banks no longer taking proprietary risk, hedge funds fearful of a correction and the ECB as the gorilla in the corner, liquidity has fallen. The ex-head of credit trading says this has made today's markets more relationship-focused and less susceptible to automation. "Everyone thinks credit trading is becoming electronified, but this only applies to small orders between $500k and $1m. Ten years ago, if you had $25m of generic bonds to sell, you'd ask five banks at once and get a market very quickly. Now, if you have an order that size, you're going to be very careful about showing it - if you ask five banks, the market will move. So, you're only going to ask people you know and trust. Credit trading today is far more about human relationships than it was before."
The way veteran traders tell it, therefore, the traders who've come of age since 2007 are schmoozers who specialize in selling into a rising market. When and if the ECB tapers its involvement, they could be in for a shock. "Everyone knows that soon as the ECB indicates it’s changing its bond buyback policy everyone in investment grade will face significant losses,” says Gargour. “The generation that runs credit trading now doesn’t have experience with defaults on credit cycles, but the market is going to change and these guys are about to gain some wisdom.”