Talk:Discretion

Well, let the JC tell you a cautionary tale.

A cautionary tale

As well as lending on margin, a prime broker runs banking services for its customers, who may deposit cash with the prime broker in excess of its formal contractual margin requirements. As with any other deposit accounts, a client may ask for its money — in excess of its margin requirement — at any time.

To allow themselves a degree of operational flexibility, prime brokers tend not to agree timeframes within which they must disburse cash, but by unerring practice it tends to be same day, as long as the request comes in early enough. The broker needs to check the client’s positions, satisfy itself the client is sufficiently margined, make sure the relevant operational teams have what they need and everything is in place to get the money out the door. So, a bit of flexibility, in case things get gummed up or the market is crazy.

Sometimes, more petulant clients ask for a commitment to disburse cash same day; to which the prime broker’s says, “okay, as long as you commit to make your request by ten o’clock in the morning, I will commit to returning it same day.”

Notice the flexibility the parties otherwise have is being eroded. You would think in an environment of trust and good faith you wouldn’t normally like to erode one’s discretions, but prime broking is not always such a place of warmth, sweetness and light.

Now, once upon a time, one such client rolled up, at ten minutes past the agreed deadline for a withdrawal request, and asked its broker for some money back. Quite a lot of money, but it was excess to margin, so you know, that’s how it goes.

The prime broker ran its checks, cleared all balances, checked its margin levels, saw green lights across the dashboard and disbursed the money, exactly as you would expect a good banker to do.

Alas, that was the day in March 2021 on which a peculiar corner of the market melted down taking that client, all its positions, and ten billion dollars of borrowed money across its six brokers, with it. The awful lot of money that that prime broker lost would have been a bit less had it not paid out all that money.

Now, to be clear: our prime broker had been remiss in its risk management: res ipsa loquitur: it lost money: it must have been. It did not see the incipient risk presented to this client by its positions in that peculiar corner of the market. But that was a different business failing. In honouring the withdrawal request, it got things right. Had the failing bit of the risk management operation been on the job, it would have show a red light on that dashboard, the broker would have recalculated required margin and kept the money. But it did not. This was not the cash operator’s fault.

When it came to the inevitable recriminations, the bank’s crack, rear-mounted hindsight division — internal audit, compliance, business management — rolled in. They found the client’s contract, that 10.00am deadline, which they noted had passed. They asked one question: why was no-one monitoring our legal rights? Why did we pay out when we were not obliged to?

Have a guess who they fired.