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Phil Albinus
Phil Albinus
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Market Behavior Continues to Defy Logic When It Comes to Risk Management

The sovereign debt crisis has been going on for months, even years, but firms are still unprepared to manage risk and take precautions as they face increased regulation and greater market volatility.

Speaking with a hedge fund manager recently, I was shocked at how little has changed on the Street. Discussing the myriad challenges facing today's portfolio managers and prop traders, he reeled off a list with ease: increased regulation, a technology arms race, low levels of liquidity, greater market volatility. Finally, he added the situation in Europe. But wait, I asked, isn't every fund manager hedged against Europe? The sovereign debt crisis been going on for months, even years -- firms are prepared, right?


Two years after Dodd-Frank became law, the financial reform package appears to be dying a slow death, and many experts suggest that the Volcker Rule -- perhaps the most important and controversial aspect of financial reform -- will never work. Advanced Trading's July digital issue looks at what, if anything, on Wall Street has changed since the credit crisis and examines the challenges regulators face in enforcing the ban on proprietary trading.

Absolutely not, he said. There are plenty of experienced hedge fund managers with impressive track records who are still betting on the euro and who still have a ton of exposure to Greece, Spain and other struggling nations. After a near collapse of the global markets four years ago, we continue to witness market behavior that defies logic.

It's as if the bailouts and the shotgun investment bank mergers never happened. Just look at the alleged use of client funds by MF Global -- you would think that the former head of Goldman Sachs and a senator from the great state of New Jersey would have known the consequences. Or cast your eyes at J.P. Morgan's recent multibillion-dollar bad bet by a trader known as the London Whale. And Allen Stanford and former Goldman executive Rajat Gupta were found guilty of running a Ponzi Scheme and profiting from insider trading, respectively -- further proof that intelligence doesn't equal Street smarts.

Meanwhile, reining in risk on Wall Street is proving to be a challenge for regulators, as well. Even as they prepare to roll out the Volcker Rule this month, regulators are still struggling to determine how the rule will function and how they will enforce it. While banks will struggle, according to one expert, "to be able to draw the line of demarcation between their hedging and dealer market-making activities versus their risk activities," the regulatory task of actually enforcing the Volcker Rule may be an impossible mission.

[The No-Shame Game on Wall Street: Bad Brazen Behavior Is Not Showing Any Signs of Leaving the Scene.]

Two years after the Dodd-Frank Act was signed into law, it seems fair to wonder if it will see its third birthday. Beyond the Volcker Rule, many provisions of the 1,200-page Dodd-Frank reform have yet to be enacted. And, according to SimCorp's Else Braathen, buy-side firms are "woefully underprepared" to meet the law's requirements. Many investment firms claim that Dodd-Frank's fine points remain unwritten (and they're right), while others have hired lobbyists to weaken, blunt and overturn the law itself.

Perhaps Heidi Moore, New York bureau chief for "Marketplace," said it best in describing J.P. Morgan CEO Jamie Dimon's testimony before the Senate Banking Committee last month: "This was a wake for Dodd-Frank," she said. Let's remember this the next time a firm asks for a bailout or the industry assures us that it has all of its risk practices in order.

Phil Albinus is the former editor-in-chief of Advanced Trading. He has nearly two decades of journalism experience and has been covering financial technology and regulation for nine years. Before joining Advanced Trading, he served as editor of Waters, a monthly trade journal ... View Full Bio
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