Many involved with prop trading can’t see how regulators will ever know what they’re up to at all times.
Even people within a prop trader’s own company do not know exactly what’s going on:
Reuters: “How will a regulator know why I’m making a trade?” said one trader at a major firm.
One former corporate strategist at a US bank said his department often was not sure why the bank’s own traders had exposure to an instrument or asset — whether it was for customers or to bet with the bank’s own money in a proprietary trade.
Certain practices might be clamped down on, but there will always be others, given that in the end the limits of proprietary trading are only bound by a trader’s imagination. Keep in mind we’re only talking about legal, fairly legitimate practices here, of which there are many you simply can’t ban:
Consider a corporate bond desk. A client might want to sell USD 1 million of IBM bonds. The trader would buy those securities, but she might not be able to sell them to another client for hours, days, or even months. In the meantime, she would typically lower the interest-rate risk associated with holding the bonds by shorting USD 1 million of Treasuries, or using interest-rate swaps. And she could buy credit default protection on USD 1 million worth of IBM debt to lower her credit risk.
But for each of these positions, the size of the appropriate hedge is subject to debate — for example, if credit derivatives tend to respond more to market movement than the corporate bonds, it might make sense to buy protection on just USD 900,000 of debt.
To an outsider, that transaction could either be interpreted as a sensible way to decrease risk or a bet on the credit quality of IBM. And when a trader has thousands of positions on her books, understanding the exact risks she is taking can be difficult.
There are just too many products, ways, and reasons to trade.