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Terri Duhon is the author of How the Trading Floor Really Works. She is a financial market expert with over 2 decades of experience in financial markets. She graduated from MIT in Math in 1994 and immediately joined JPMorgan as a derivatives trader on Wall Street. While at JPMorgan, she was instrumental in developing the credit derivative market globally. Her time on the trading floor has been documented in the book Fool’s Gold as well as by PBS’s Frontline. In 2004, after 10 years on the trading floor in New York and London, Terri founded B&B Structured Finance Ltd, which provides expert consulting and financial markets training. She has led expert witness teams for financial litigation in both NY and London and assisted asset managers in assessing financial market risks. She sits on the board of Morgan Stanley International, lectures at Oxford University Said Business School, sits on the board of CHAPS Co and was a founding member of the Women’s Leadership Group for the Prince’s Trust. She lives with her family in London.
Terri Duhon Q&A about How the Trading Floor Really Works
Q: Why is what happens on a bank trading floor so opaque?
A: There are two key reasons the trading floor is opaque, sometimes even to those who work on the trading floor itself. The first reason is the language barrier. The world of trading financial products has its own vocabulary as well as style of communication. In effect, the trading floor has its own language. At the same time, each person’s role is very specialized, which makes the lines of communication around the trading floor very tight. Clients speak to a sales person and a sales person speaks to a trader. These two individuals, sales person and trader, generally do not pass that information on to anyone else on the trading floor because the information is often confidential and also because no one else strictly needs it. Thus the person who is putting the trade into the bank’s systems doesn’t even know why the trade was done. Imagine the challenge of the new hire, the smaller corporate client or even the regulator…
Q: What role does the bank trading floor play in financial markets?
A: The trading floor is where banks provide liquidity to financial markets. In other words, it is where banks buy financial products when their clients want to sell and vice versa. It plays a central role in financial markets of always ensuring that there is a price where clients can buy and sell financial products. Of course it may not always be a price clients are happy with, but it is a price. Without a price on financial products, it is hard to determine what value any financial product has. In the bigger picture, everyone operates on the basis of what their assets are worth i.e. if you don’t know how much you are worth, you don’t know how much you can spend and thus money doesn’t go round…
Q: Why do banks need to take risk to play this role?
A: When a bank puts a price where it is prepared to buy and a price where it is prepared to sell a financial product for a client and the client decides to trade on one of those prices, the bank has a position in a financial product. For example, if the bank buys a stock from a client, it now needs to sell that stock to close out the position. If there isn’t another client or another bank immediately interested in buying that stock, the first bank will need to own the stock for a while. In that time period, the price could fall and the bank could lose money when it is finally able to sell. Of course, this is the risk that trading floors are supposed to be taking, which is why banks generally get to buy on the low price and sell on the high price.
Q: Is the risk well managed?
A: Risk management tools are owned and risk management systems are in place in most major banks. But these systems can only do so much on their own. How they are used are based on subjective decision making. Aside from fraud, this is where the mistakes are made. In particular the risk management culture of a bank is what determines how risks are taken. Sadly, a lot of banks aren’t winning prizes for their performance in this space.