Proprietary trading

Proprietary trading at banks, trading in financial instruments ( cash, securities, foreign exchange, varieties, precious metals or derivatives ) mentioned that is on their own behalf and for its own account and not directly caused by, customer business.

Objectives

Proprietary trading seeks to profit in order to improve the results obtained from the customer business. For proprietary trading both banking book and trading book positions may be used; typically, however, is the use of the trading book for proprietary trading. Proprietary trading can also be done but indirectly from the banking book if the fixed asset attributable to customer transactions not traded at the close of business at the latest (ie, liquidated ) have been. Then the relevant operations to reclassify in the trading book, because the service nature of these customer transactions is called into question, since it speculative purposes be watched at least.

For proprietary trading purposes, credit institutions use the information and tools that are available in the client business, for their own purposes. In addition, the proprietary trading can help to ensure that the human and material capacity to trade are utilized higher in banks in order to cover the high fixed costs in these areas better.

Legal Issues

Proprietary trading is a financial service within the meaning of § 1 Article 1a No. 4 of the Banking Act. When trading on behalf of a client as principal, the Institute enters its customers over not as a commission agent, but as a buyer or seller. Even if it is civil law this is a pure contract of sale, the business is service within the meaning of the EC Investment Services Directive. Proprietary trading in the narrowest sense is based as " assigned activity " in § 1 para 3 of the Banking Act No. 5, assuming that performs trading solely for its own account, the financial institution and there is no service for third parties in the broadest sense.

In order to limit the risks from proprietary trading, write the § § 294 et seq Solvency before binding of the open book items ( inventory risks ) to the own funds of a credit institution. Exceed the total open positions ( according to one of the two alternatives ) 2 % of own funds, these open positions with 8% weighting ( § 294 para 3 of the Solvency Regulation ) are. This automatically results in a volumetric limitation and risk- intensive open proprietary trading positions.

Short-term achievement of a proprietary trading success requires the assignment of the principal transactions for the trading book directly with the transaction. Proprietary trading positions are those positions, " which are held intentionally for short-term resale or where the intention is to exchange and interest rate fluctuations to be drawn from current or soon-to- expected price differences between the buying and the selling price or other profit. "

To be understood as " trading profit ", according to the explanatory memorandum to the 6th amendment to the Banking Act, the net income or expense in accordance with § 340c paragraph 1 HGB (held for trading ).

Comparable, but delineate from proprietary trading, also covers the purchase or sale of financial instruments for its own account, which is not a service for others within the meaning of sentence 1 No. 4 of the Banking Act. This financial business is known as proprietary trading, which, when operated in addition banking or financial services are provided, in accordance with § 32 para 1a German Banking Act also requires permission.

Activities and risks

While otherwise meet mainly the banks requirements of their customers, may be present for proprietary trading a wide range of job profiles.

Operational proprietary trading activities are the purchase or sale of securities, foreign exchange, varieties, precious metals or derivatives or recording or investment of money. This can be done tactically through arbitrage or speculation, which are as strategies of development of open positions or close out, hedging or Covering of open positions in trading or investment books available. For proprietary trading include both short-term trading transactions and entering into long- term strategic positions. The price management is a part of proprietary trading, even if it was contractually agreed with the issuer of securities.

Proprietary trading is not without risk. If open positions up or hold to go a the banks proprietary trading risks to which they connect certain earnings expectations. This is typical market price risks that are associated with a risk of loss of financial products. In addition, the proprietary trading shops are - like all outward banking - the counterparty or settlement risk. In volatile markets, these risks increase, so that the possibility exists to use risk mitigation techniques; this includes clearing, hedging or Covering.

Functions

Proprietary trading of credit institutions has important balancing functions. Approximately in stock trading banks have in the past can help to stabilize the rate -regulating stock prices, in particular, where 23 para approached the function of a market maker in the sense of § 4 of the WpHG. This also applies to market fluctuations in other financial instruments, so that temporary fluctuations can be leveled largely or entirely through proprietary trading.

Organization

MaRisk generally provide an organizational separation between the market area and the back office, to avoid personal conflicts of interest. In addition, dedicated written work instructions are prescribed, the institute should internally provide a uniform and risk-conscious organization of proprietary trading. To limit the same institutional proprietary trading risks, dealer limits are given, which consist of the following sub- limits:

• Overnight limit is the limit of the open position at the end of the workday. It corresponds to the position limit, so the risk limit for the individual trader. Depending on the assessment of market risk (4% change in currency eg 1 % interest rate, ) or more sophisticated methods ( such as Value at Risk approach ), the calculation of risk per trader in a scenario analysis are defined.
• Intraday Limit / Daylight limit is the permission to temporarily establish an open position during the working day. This intraday limit is set depending on the skills and position of the dealer and the market liquidity of the traded instrument. The limit can also be dependent on whether a bank in this instrument holds a market-making function or not.
• Quota limit is the limit of the volume for which must be quoted. Up to the prescribed limit then a merchant has the right to request to name a price at which the bank is ready to enter into commercial amounts. Similar to the intraday limit the quota limit of the qualification and function of the trader, the market liquidity of the instrument and the role of the bank depends in this market.
• Stop-loss limit limits the maximum loss that the bank is willing to take on a position. If this limit is reached, the dealer must close his position, even if he still has free position limit. It can also be drawn to the overnight limit.
• Maturity mismatch Limit: This also makes a limit on the open risks in the individual running times can be set in addition to the overall position limit yet. Thus, the maximum open position in intraday limit a trader be additionally limited by, for example an open position in the period up to 6 months on amount is higher than limits for maturities up to 1 year.

Additional limitations can still by instrument limits, which limit the risk of liquidity in each market, and maturity limits, which will limit the maximum duration for individual instruments, can be achieved.

Also of importance is a sensible division of functions such as on trade, risk management and support. The dealer handles the actual buying and selling transactions in compliance with the limits and the strategies. The risk management is the responsibility limit setting and control, and the development and monitoring of banks' internal strategies for proprietary trading. The support functions include the development and operation of information systems, detection / monitoring of business transactions and the monitoring of regulatory requirements.

The user can specify in proprietary trading between three different forms of organization. They differ from each other by the question of where and how a trading book is out. Then there is a single Inventory, Inventory and Multiple Sequential Trading Model.

The simplest way of proprietary trading offers the "Single Inventory Model ". Here, only a trading book shall be kept in one place. The sales markets the products in the trading book in a decentralized world; However, the power of attorney on the financial statements is the responsibility of traders at the place of management of the trading book. Centralized are also risk management and support functions.

When "Multiple Inventory Model ", however, trade books are decentralized out on at least two international financial centers. The decentralized management is based on the idea that certain financial instruments are regularly traded on markets defined and thus have a so-called " Natural Home ". For example, e - bonds could be held in a trading book in Frankfurt, while U.S. Treasuries would be held in New York. Only the local dealer have the authority to undertake transactions for the trading books. To ensure a 24 - hour trading, it is possible after the closing of the Natural -home market to pass on trade limited powers for certain positions within prescribed limits to others, not really relevant parts of the company. Risk monitoring is the place where the trading book decentralized.

The "Sequential Trading Model " is the third and most differentiated form of proprietary trading at banks and comes with centralized risk management frequently. Here, the trade managed a joint assets in different trading venues. For a particular financial product, there is a single, global trading book, which is passed continuously from one location to another once every 24 hours around the globe. In contrast to the "Multiple Inventory Model " here all dealers in the parts of the company an unrestricted commercial license for all positions of the global trading book is issued. For each book there is a global chief dealer who controls assigned by the central risk management trading limits and is responsible for the economic result. The here mutually delimited trading models can not distinguish always against each other in practice.

Risk Management

The risks in proprietary trading consist primarily of market and liquidity risks. From the perspective of banks caused by unexpected market risks, adverse changes in interest rates, exchange rates and other prices. Here is the credit risk to be considered by changing credit spreads also. Other not to be underestimated risks are operational risks (such as the failure of data processing systems ) and legal risks (such as unforeseen changes in laws ). The dimensions of market risks are measured by the value-at -risk. The value- at-risk of the trading book is the upper loss limit, (eg 99% ) is not exceeded at a given holding period with high probability. The global proprietary trading requires in particular in the multiple inventory and Sequential Trading a dynamic risk management process with continuous, decentralized organization considered monitoring and controlling the risks incurred.

Successful realization

As a " trading profit " according to the explanatory memorandum to 6 of the Banking Act amendment is the net income or expense in accordance with § 340c paragraph 1 HGB (held for trading ) to understand. A trading profit is considered realized when the closing is recorded, because profit contributions are only included if they are made ​​at the balance sheet date ( § 252 Section 1 No. 4 HGB).