Inside the struggle at the top of Citigroup's equities unit that's a window on the latest Wall Street fad
- A struggle at the top of Citigroup's equities division several months ago resulted in the departure of the bank's global head of cash trading.
- Executives disagreed over how integral a role the firm's central risk book should have in its overall equities strategy and how it would interact with clients.
- The dispute is a window into Wall Street's latest fad as banks turn to central risk books as a lifeline for cash equities trading desks suffering from shrinking commissions and new research rules.
Armando Diaz didn't see it coming.
One Friday in March this year, Diaz, who'd joined Citigroup two years earlier as its global head of cash trading and helped the bank claw back equities market share from competitors, was suddenly summoned to his boss's office hours before US stock markets would open.
In an office looking out on the third-level trading floor, where baseball bats stand in a corner and a bottle of whiskey sits on a shelf, Citi's global equities co-head Dan Keegan delivered the news: Diaz was out of a job.
For months, Diaz and Keegan had gone back and forth over Citigroup's central risk book (CRB), a desk where technology aggregates risk across dozens of traders so it can be actively managed. The CRB was led by an executive called Peter Lambrakis, but the profit and losses of the book had been Diaz's responsibility, a tension-inducing mismatch. And Diaz and Keegan couldn't agree on how the CRB should be positioned.
In the weeks following Diaz's departure, Keegan elevated Lambrakis, handing him Diaz's old role overseeing cash equities trading in addition to oversight of the CRB. The change meant that the financial results of the book would now fall under the executive in charge of the strategy, Lambrakis.
Ultimately, it had been a case of Diaz versus Keegan, and Keegan, the boss, had made his move.
This series of events was described to Business Insider by multiple people familiar with the matter. Citigroup declined to make Keegan, Lambrakis or Diaz, who is still subject to a separation agreement, available for this story.
Trading's a cutthroat business, and a disagreement between senior managers, in this case over how much importance and balance sheet to assign an emerging strategy, isn't out of the ordinary. Diaz and Keegan, with more than 50 years experience between them, didn't see eye to eye on the strategy, according to people who know them.
But this was a sign of something larger, a symbol of the increasingly important role that so-called central risk books play in global cash equity markets.
"Banks are building these up, investing in them and hiring personnel," said Alexey Surkov, head of Deloitte's model risk management team, who declined to comment on any specific institution. "It's on the rise."
As Wall Street firms have tussled for supremacy in stock trading, 20 years of shrinking commissions have forced them to get creative. In the early days, firms embraced electronic trading and dark pools, or used more balance sheet, to woo clients and wrest business from rivals. But as technology became commoditized and new rules made it more expensive to hold inventory, firms came up with ever more innovative solutions.
One of those, the central risk book, is now taking hold across the industry, with implications for everything from how clients buy and sell shares to where the next trading loss may emerge.
"Aggregating risk from individual desks into a central risk book allows us to better understand the market and also provides uniform analysis, so our management team has a better understanding of measuring exposure and offsetting risk," Keegan said in a statement provided by a spokesman. "It also allows us efficient management of risks and enables us to optimize across all desks while availing clients of enhanced liquidity as a means of improving their execution experience."
Early days
To understand one of Wall Street's latest fads, it's important to understand its origins.
Central risk books sprouted out of the rubble of the financial crisis, after firms like Goldman Sachs moved more quickly and effectively to respond to market developments. The bank possessed an unrivaled view of risk that uncovered early signs of trouble and helped managers see positions across the bank, according to an August 2017 report from consultant TABB Group. Rivals took note.
Regulators did too. Eager to prevent another crisis, they pushed the industry to improve its risk management practices and develop an enterprise-level approach. At the same time, banks were looking for ways to save costs and gain a leg up on rivals. And more recently, European rules to un-bundle research from trading have made execution more important and hastened their development.
At Citigroup, senior equities trader Mike Pringle took some early steps to establish the bank's central risk book. He joined the bank in 2009 in London and initially set it up as a way to make money, a sort of proprietary trading desk that sat on top of other market-making teams, according to a person with knowledge of the effort. Diaz, during a first stint with Citi that ended in 2011, worked on that early effort.
But the strategy never gained widespread adoption.
A change in approach
As the years went by, Citigroup's approach adapted with the industry. Many of the banks which had early versions began to move away from taking directional bets and positioned them as a way to provide client liquidity. Most firms now run them to break even, according to nearly a dozen Wall Street equities traders.
The strategy uses technology to tie together as many of the firm's trading desks and products into one central repository, giving managers a consolidated view. Firms can then take active measures to manage it, like hedging the risk in the market, or even offering clients different prices based on the riskiness of the trade.
"Banks are looking at 'how do I tie my central risk book capital base into my clients needs and order flow?'" Larry Tabb, founder of the market-structure consultancy Tabb Group, said in an interview. "It's a real change in the way that folks think about risk, in the way they organize their trading desks."
Goldman, Barclays, Credit Suisse, Deutsche Bank, and JPMorgan have central risk books in addition to Citigroup, according to TABB's report and traders. Morgan Stanley and Bank of America Merrill Lynch do too.
The shift has ramped up the competition for top quant talent. Citigroup lost a senior central risk trader in Dariusz Kowalewski to hedge fund Citadel in October. Sebastian Ridd, the head of program and cash trading in the US, left to work on Millenium's central risk desk just prior to Diaz's ouster.
Notable hires at other banks include Michael Steliaros, who left Bank of America in November to join Goldman Sachs and oversee its CRB, among other responsibilities, as global head of quantitative execution services. In July, Mitrajit Dutta, a top quant and head of model-driven trading at Credit Suisse, reportedly decamped to help build out Bank of America's central risk capabilities.
"In the past two years, every major US and European bank has increased their interest in hires of central risk book professionals," said Joel Sichel, the head of systematic trading at GQR, a headhunting firm.
Butting heads
At Citigroup, the CRB would eventually be Diaz's undoing.
Hired in 2016 to revive a moribund cash trading business as part of larger ambitions to become a top equities shop, Diaz helped Citi make inroads. The bank took aim at a corner of Wall Street dominated by JPMorgan Chase, Goldman Sachs and Morgan Stanley, and last year, moved past Deutsche Bank in the league tables and narrowed the gap to Credit Suisse. In the first half of this year, Citi's revenue from equities rose 29% to $1.97 billion.
Despite that progress, Keegan and Diaz couldn't agree over how big to make the central risk book, according to people with knowledge of the disagreement. Keegan wanted to expand its size and scope to create as much liquidity as clients might want, the people said. One plan would give the firm's top clients a view into every position the bank held, according to one person.
Diaz thought the CRB shouldn't get bigger if it couldn't perform, and the CRB should be one of several products presented to clients, according to a person familiar with his thinking. He favored other ways of providing liquidity and worried about making markets in areas where the bank didn't have an edge. Keegan worried that kind of thinking would unnecessarily limit its scope, people said.
The debate is a familiar one on Wall Street. While Goldman Sachs has put the CRB at the center of many of its flows, Credit Suisse sees it as just one of several options, according to industry sources.
But Diaz and Keegan also disagreed on pricing. Keegan believed in charging higher prices or imposing a bigger discount to clients with trades that might take days to exit, while Diaz wanted prices to be a function of market conditions rather than client characteristics, sources said. The disagreement came to a head earlier this year when the book lost money and dented Diaz's performance.
Central risk books tend to work in an environment where dispersion is low or falling, because hedging the book - say by selling Intel to offset a long position in International Business Machines - relies on historical correlations. When dispersion spikes, as it did this year, those correlations break down and the book falls out of balance. TABB Group predicted as much in its report last year, and offered a warning.
"The one thing we know from history is that historic correlations will, of course, breakdown when they are needed," according to TABB's report. "Buttressing your institution on historical metrics and analytical relationships will eventually fail."
The strategies are also reliant on the bank's technological prowess and the skill of its traders. While the early versions relied on human traders adept at taking proprietary risk, the current iterations are much more reliant on technology and vulnerable to glitches. That means a strategy meant to reduce risk may ultimately increase it.
For Citigroup's approach, it's too soon to tell.