Proprietary trading in decline...

There was a quite superb article in today's (1/9/10) FT which links perfectly to the new updated section on Investment Banking (article 7, page 36) of my book Reading and Understanding the Financial Times, 2nd edition. The new article is titled "JP Morgan to close "prop" trading division which is remarkably similar to the one I selected to analyse from November 2008. However, the reasons for JP Morgan deciding to close this form of trading is somewhat different this time around. Before we discuss this we should define our terms...

As I say in the "Key terms" section proprietary trading is where the investment bank uses its own capital to fund trading strategies that are designed to earn them significant profits. This form of trading can be in a wide range of financial markets.

In the latest article the form of trading being cut is that involving commodities. As a result a large number of investment banking jobs could be lost as this trend to reduce "prop" trading widens. The reason for this change is the so called "Volcker rule" which is a key part of the new Dodd-Frank law (the new US Financial Services Legislation) which aims to get banks to become far less risky in terms of how they manage their money. This section of the new law is named after Paul Volcker the ex-Chairman of the Federal Reserve Bank who was responsible for this move. Under the legislation there will be a ban on proprietary trading and a limit on the amount of capital that the US banks are allowed to invest in hedge funds and private equity. The motivation of this move is to force banks to take far less risks with their own balance sheet funds. In addition it is designed to get the Investment Banks to instead focus on servicing their own clients' needs. This means it could be a tough time for traders who specialise in proprietary trading. Indeed we might soon see a few more second hand Ferrari's for sale!