We are meeting for a sustainably sourced sandwich in the City, one sunny, spring day in March. He is a relaxed-looking man in his late 30s, originally from continental Europe, who calmly formulates precise sentences.
He designed what are known as "structured equity products" for a major bank until recently.
Joris Luyendijk talks to a former structurer at a bank who argues the culture of finance should be more like rugby's, less like football's
"Short-termism is the big problem in finance. Imagine you're running a marathon, 42km, but your performance is evaluated every 100m. This is life for many asset managers at pension funds, the people deciding where our pension money gets invested. No wonder asset managers are all sprinting and not taking into account sustainability issues in their decision-making.
"Derivatives are like nuclear power. Used sensibly you can do useful things with it. Used for aggressive purposes, it becomes a weapon of mass destruction.
"I loved doing what I did. In the end I left for two reasons. One was internal politics – I was tired of fighting colleagues sitting next to me who were trying to steal the business I originated. The other was personal values – I felt just making large returns for your shareholders was not all there was to life.
"One of the problems with management in the financial markets arm of investment banks is that people are promoted for reasons that have nothing to do with their management skills. If you are a successful trader, and you become a managing director, suddenly you have a team of people assigned to you. Traders are relatively introverted individuals, and now they have to manage a group of individuals ?
"Fighting colleagues … how that would work. I would find a client in the UK who is having a tax problem with a portfolio of French shares. So the deal originates with my relationship with this UK client. But since these are French shares, I have to bring in the French specialist, and suddenly he says: 'I have to be in the lead on this deal!'
"Since the product I am putting together touches on tax issues, suddenly my tax specialist colleague claims this is all his territory and the deal belongs to him.
"However, half the people there I'm still in touch with. They were a decent bunch. Basically you had this brotherhood of geeks; people with such levels of expertise that they didn't need to be so ruthless. If you are in a niche market, those people were fantastic to work with.
"You might say, the culture in finance is simply how humans behave. It's not exclusive to banking. You might say it's like football, where on one level it's your team against the other team, but each individual player is also competing with the others for a place in his own team. And if you can score yourself, rather than let the other guy take the glory … You see how this works. Falling to the ground to get a penalty kick … Constantly flirting with other teams or agents, even going as far as refusing to play because you want to be bought by an ever better paying club, like Tevez does … Screaming at the referee to put pressure on him …
"Every weekend, millions of people watch football players behave like this, and everybody seems to mind or consider it unacceptable. But think again. Rugby. That's a sport as tough and manly as football. Yet no one really fakes stuff to get his opponent booked, or get a penalty kick. Only the captain talks to the referee. At the same time players get hit much more and much harder than in football.
"I am convinced the key is values. Rugby is governed by different set of values and this translates into a different kind of behaviour.
"How do you create that change in finance ? My theory is that we need to focus on the ultimate asset owners. The banks work with money that is, in the end, owned by governments or individuals, who are saving or have paid it into their pension funds.
"Now think of the asset managers at those pension funds. They work for us ? Why do they invest in Goldman Sachs? It's us, shareholders through our pension funds, who own huge parts of the investment banks whose behaviour we decry.
"Why don't the asset managers take action ? Why don't we take action ? Do the owners of Goldman Sachs really want it to change, or do they in turn want to squeeze the maximum out of them? We have to vote with our investments and our consumption habits.
"I have read Greg Smith's resignation letter from the equity derivatives desk at Goldman Sachs. For me, it goes back to the values in an organisation. If you could sell your product for double the price, would you do it ? I would say, in business, that's legitimate, provided your clients have adequate information.
"This is an important rule with structured derivatives that clients ignore at their peril. You have got to read the small print. You need to bring in a lawyer who explains it to you before you buy these things – otherwise there is information asymmetry.
"There is a lot of mis-selling, and not just in derivatives. The mortgage brokers in the US who sold low-income people those sub-prime mortgages. Low-income people didn't understand finance, didn't comprehend that interest rates would jump after a short discount period. That's mis-selling.
"If a financial tool is abused and mis-sold, this does not disqualify the tool.
"My job was called structuring. I would put together structured solutions using derivatives for clients. There are mainly four silos of clients in derivatives: the so-called 'institutionals' like pension funds, hedge funds and asset managers – basically people managing other people's money. Or they would be governments, though not specifically equity derivatives. Then there are companies, which we call 'corporates'. Finally there are the so-called 'high net-worth individuals' – really, really rich people.
"A derivative can be really useful. A farmer has no idea of weather conditions in the coming months. There may be a flood, there may be a drought. His harvest may be fantastic, it may all be lost. Say this farmer needs £100,000 to get started for the new season. Getting that money from a bank without any guarantee can be tough. But now the farmer enters into a derivative, where his counter party agrees to buy his harvest for £120,000 for delivery at the end of the season. If the harvest is poor, he'll still get the £120,000, and the deal 'goes against his counter party' as we call it. If the harvest is fantastic and ends up worth more than £120,000, his counter party makes a profit.
"Either way, the farmer has financed his harvest in an efficient way as he's priced in his expenses and a known profit. This is a textbook example of the good use of derivatives.
"But there's another side to this. Derivatives can be complex and relatively costly to implement, so it's often mostly the big players in farming who end up using them.
"Say you are a pension fund and you are worried about the state of the UK economy, and you want to protect yourself against a downturn. Then you can buy a derivative that says: if the FTSE goes below a certain level, you will be paid a certain amount. This would be called a 'put option'.
"Next you have to decide on the duration. You want the protection to last three months, six months … The thing is that in this case a derivative costs a lot of money, the way an insurance premium costs money.
"What I have seen happening is a very big pension fund considered getting protection mid 2007. They waited and waited, the crisis happened and then they were too late. They ended up down 40% on their UK portfolio by 2008. It's all about timing.
"Another sort of derivative solution may involve a company holding a strategic 5% of shares in another company. Now they want to sell that 5% but the share price has gone down, so they want to dispose of it but still partially benefit in the upside over the next few years. I would design a bespoke derivative that met those needs. As I said, I loved doing what I did. It was intellectually very challenging.
"Was this morally ambiguous, helping corporations efficiently organise their taxes through complex financial engineering ? The way private equity and hedge fund firms have moved everything offshore and they're paying basically no taxes … That feels more immoral to me. And everybody just accepts this. I'd say that goes much further than corporations using every possibility the law affords them to keep taxes efficient. Again, I don't mean offshoring. That's possibly hiding things.
"You have to realise that all corporations are actively managing their taxes given current regulation and they generally don't do anything illegal. Internal revenue signs off on those deals. My sense is that there are bigger battles out there to fight, than this one, like the way corporations pay their lower-income employees or squeeze their suppliers. These issues are far more important if we want to build a more sustainable economy.
"I used to earn just over £110,000 and then a bonus of two or three times my salary in a good year and between one or 1.5 times in bad years (although our unit was always profitable). By the way, beyond the first £110,000 of a bonus, I would get more than 50% in bank shares, which you could only sell after a few years. So actually they are now worth much less.
"The financial sector has grown so much over the last decades. There are so many more of us now saving up for a pension, in part due to our lack of trust in our governments to pay us a pension to retire on. In the last 30 years there has been a huge demand for sophistication in investments in order to meet that demand. What are all these asset managers at pension funds managing our savings going to do ?
"They look for diversified investments. They want assets that are uncorrelated, meaning if one goes down, the others don't automatically go, too. We thought we had this figured out, but the crisis proved us wrong. What happened was that when the 'asset pool of mortgage securities' went down, asset managers had to take money out of good asset pools to compensate for others. As a result these good asset classes went down, too. They were not correlated as assets, but they were through the money supply.
"You have delta-one traders and volatility traders. Delta-one are products that mimic one-for-one an underlying asset, for example the FTSE 100 index. It is easier to buy one simple contract, albeit limited in time, than to buy the basket of all the 100 stocks making up the FTSE 100. Volatility traders trade only one direction of a share or index price (eg the price going up). In fact they end up trading the speed in movement of an underlying, not the share price itself. It's a different world. Volatility traders are in a multidimensional world, and often a very special animal. Lonely, introvert, often prone to substance abuse. They are like those guys in air-traffic control towers. They can hold in their heads a matrix of many variables at the same time, with new information constantly coming in at high speed.
"If you look on a trading floor, you can recognise the cash desks as they have two screens; one to chat with their girlfriend, the other with their outstanding deals. The volatility trader will have eight to 10 screens.
"Then you have flow and structured products. Flow-traders execute simple trades, often listed on an exchange, on behalf of clients, and make their money mainly off commissions like a broker. They deal in the plain vanilla stuff on delta-one or volatility, standardised contracts with small margins that are traded in large volumes. On the other hand, structured products (they are called OTC or 'over-the-counter') are contracts agreed between two parties where the documentation is specifically tailored to the situation. Nowadays, there are standards promoted by ISDA (International Swaps and Derivatives Association) used by all parties, which guarantees a common language.
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