Monday, November 09, 2009

Investment banks should be banned from proprietary trading

Angukia investment bank has 3 employees.
  1. A1 who is the broker. She executes buy and sell orders on behalf of Angukia's clients (corporate, high net worthy and raia).
  2. B1 is Angukia's proprietary trader. He buys and sells various instruments using Angukia's capital.
  3. Finally C1 is the investment banker. He advises Angukia's corporate clients on mergers, divestitures, acquisitions, financing and capital raising events (such as rights issues).
In the West you'd be told that there is a Chinese wall between the various activities that Angukia undertakes such that C1 and A1 never converse about the deals passing through their desks. You'd be told that if A1 received an order for 5% stake in a particular listed share, she'd never tell B1 who was thinking about selling the 1% stake that he had built up for Angukia.
This is ofcourse not possible.
In the developing stockmarkets like the NSE, where integrity may not be as established, it is essential that IBs not be part of the trading in the market.


Maishinski said...

Concur Fully. Please send that excellent example to CMA (they're collecting views!).

How about this:
- You place your BUY order
- Angukia takes the details BUT doesnt lodge it in the ATS system
- Angukia monitors the market and sees the direction
- angukia takes a position (buys) with his/her own cash
- angukia then sells to you at higher price (but not too high to arouse suspicion).

All angukia needs is 1% returns every day over hundreds of minute transactions.

Angukia can also use your orders to manipulate demand/supply without actually executing your order. Example, entering your buy order at the lowest price (or sell at highest) possible - such that it cant be executed (even if you placed at market). This can tip demand/supply numbers tricking investors.

Angukia can also "refuse" to place your order by tricking the system.
Then you get your statement showing the order as unexecuted.
Angukia then has time to play around with demand/supply...

As long as there's no immediate and (fingers crossed) direct placement of orders to ATS by investors, there will always be manipulation at our expense.

gumzo said...

Well said Maina T! Nyambura

MainaT said...

Maishinski :-) the NSE's founding fathers don't anything about modern share-trading