There's a story going around about last year's surprise devaluation of the Swiss franc. It says the junior FX traders at one of the many European banks which lost millions of dollars that day, just couldn't cope. "They were absolutely buried," says Steven Goldstein, a former senior rates and FX trader at Credit Suisse who now runs Chrysalis Performance Coaching. "They lost a lot of money and they lost a lot of clients."
While all areas of fixed income have suffered from the attrition of senior staff in recent years, departures have been particularly acute in foreign exchange (FX). It's not just the rise electronic trading systems, which now account for over half the market. Nor is it just the FX trading scandal, which saw a generation of senior FX traders expelled from the City. It's those things and cost cutting and the decision of some banks to focus their attention elsewhere.
“Some banks have made huge cuts to their FX trading teams over the past few years. They’ve taken a view that it hasn’t made sense to commit to FX and that they want to put their capital and costs to work in other product areas," says Alex Beresford at Engage Search, an FX recruitment specialist. Which banks are they? Beresford declined to comment, but Morgan Stanley and Credit Suisse have both made big cuts to their macro businesses in the past year, while others - like Barclays and Deutsche Bank, have hiring freezes which prevent them from replacing experienced staff with similarly qualified outsiders when they leave.
Lex Van Dam, an FX trader and former head of the proprietary trading desk at Goldman Sachs, says it's not just senior staff who are lacking - banks have gouged out mid-level talent from their FX trading operations. "In a good army, you want generals, mid-ranking officers, and soldiers. Now, banks have generals and soldiers, but there's no one between. The mid-level people have mostly gone."
This is fine - as long as electronic systems are doing the heavy lifting. But when electronic systems are overwhelmed, as during the Swiss franc devaluation, human beings come into their own.
"One of the banks I coach for kept a lot of their senior FX staff - people with 20 or 30 years' experience," says Goldstein. "They made a lot of money in January 2015. They provided a fantastic service to clients and got them some excellent prices. " By comparison, Goldstein says the banks which struggled during the Swiss franc event were those which had dumped their senior people in the preceding months: "One bank took the decision to go all out on electronic trading. It cleared the house of experienced people to reduce costs, put in an electronic system and thought it could train up juniors to run it. They were fine, until the volatility hit." He compares it to autopilot on planes: "There are times when human beings need to take control."
If Britain votes to leave the European Union, both SocGen and UBS have warned that they may be unable to make markets tomorrow. Experienced traders say the new market structure could make things worse: "A lot of senior traders have been fired in the past few years and the market is more illiquid," says a senior FX options trader at one European bank. "Banks don't store risk on their book any more - they try to intermediate it as much as possible, and combined with the tendency of electronically driven trades to overshoot, this has greatly increased volatility," he adds.
Paul Chappell, chief investment officer and portfolio manager at Currency View, an FX-focused fund manager, says 'Brexit' will amount to a stress test of the new structure of the FX market. "As the shape of the FX market changed, and an increasing proportion of trading began to take place electronically, banks divested themselves of senior people with experience of challenging markets. Tomorrow will be a test of that,” he tells us.
In this sense, the Swiss franc experience doesn't augur well. "If electronic systems are overwhelmed, you could be back to a situation where people are manually making prices and trading – basically back to how to used to be," says Chappell. - Except that banks lack experienced staff to work with top clients. "I know one client who still has trouble saying the name of one bank after the Swiss franc fiasco," says Goldstein. "The inexperienced traders there only told him at the end of the day that his order had been cancelled and put back in at a different price."
And if Britain does vote to leave and you're a 20-something trader dealing with a barrage of panicked and frustrated clients tomorrow? You might want to take a step back. During Black Monday in 1987, Goldstein said some brokers simply didn't answer their phones: "They couldn't handle the volatility and they knew they couldn't make a price to customers." In those circumstances, it can be better to bury your head than put yourself in the firing line, however much experience you have.