Computers Elbow Traders Aside

Algorithms supplant highly paid people in credit derivative markets | “It’s natural to push away from humans”

Mary Childs


Wall Street banks are replacing people with computers to trade financial instruments that once generated some of their biggest profits. Late last month, UBS, Switzerland’s biggest bank, fired its head of credit-default swap index trading, David Gallers, and replaced him with computer algorithms that trade using mathematical models, according to two people familiar with the matter who asked not to be identified because personnel matters are private. Megan Stinson, a spokeswoman for UBS, declined to comment, as did Gallers. Barclays, Credit Suisse Group, and Goldman Sachs Group also are turning over more trading to computer programs. That’s helping banks cut costs as the size of the credit-default swap market shrinks in the wake of the financial crisis. “It’s natural to push away from humans,” says Peter Tchir, founder of TF Market Advisors. “It’s been gaining momentum.”

Credit-default swap indexes are one of Wall Street’s more arcane markets. The swaps are contracts that pay off if a borrower fails to meet its debt obligations. Indexes of credit-default swaps combine swaps of many companies, allowing traders to speculate on broad economic trends. The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit-default swap indexes were at the heart of the $6.2 billion “London Whale” trading loss JPMorgan Chase suffered earlier this year.

For banks, the move is part of a trend that has seen basic trading operations turned over to computers so people can concentrate on more profitable operations. Barclays put its algorithm trading system in place to handle smaller trades in April 2011. “We want to automate that process as much as possible and free up the salespeople and traders,” says Fred Orlan, head of global credit trading. “We want to spend our time driving ideas and solutions to things that have a bigger impact on clients’ overall returns.” Credit Suisse’s program, which started in early 2011, is “a natural fit with our other strong electronic trading businesses in rates, FX [foreign exchange], and commodities,” says Jack Grone, a spokesman. Goldman Sachs declined to comment.

The decision to rely on computers is being driven by “a desire to control costs,” says Bonnie Baha, head of global developed credit at investment firm DoubleLine Capital. Building an algorithm may cost a few hundred thousand dollars, says Tchir, a former credit derivatives trader. By comparison, during the CDS boom, which peaked in 2007, managing directors on credit derivative trading desks were paid an average $250,000 in salaries and $1.75 million in bonuses, according to executive-search firm Options Group.

There may be a price to pay for such cost-cutting. Computer-driven transactions and high-frequency trading have come under increased scrutiny after the so-called flash crash in May 2010, when a 20-minute plunge in stock prices temporarily erased some $862 billion of market value. A report by U.S. regulators pinned the decline partly on an algorithm employed by a single firm trading stock futures. Says Baha: “The cost of a major trading error which could possibly be avoided by having a real human person sitting and thinking about things will far outweigh the personnel costs they save by firing all these guys.”

The bottom line Computer programs that cost a few hundred thousand dollars are replacing million-dollar traders in the credit derivatives market.


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