In writing this piece, I did not intend to glamourise trading in any way. I just thought that it would be a good idea to use my experience of over 25 years to objectively go through the numbers, because I have yet to see a trader light a Cuban cigar with a fifty pound note – but maybe all the traders I know are nonsmoking loyalists…
Please do not ask me to prove any of these numbers. They are what I feel is an average. I have worked at investment banks, trading houses, hedge funds and oil companies and they are all as different as the traders that work for them. I will mix and match between USD and GBP because all my experience is based in London and the Commodities markets are denominated in USD. Even with all these caveats and fuzzy logic, I think it is still an interesting read. Let me know what you think.
Firstly, let’s tackle the cost of trading. The components vary but the result is quite similar across the board. It costs roughly $1m per trader per year. This figure hasn’t changed much in 15 years because where we have saved money in technology, we have spent in Risk Control, Legal, and Compliance due to the changes in regulation and a general increase in regulatory nervousness. For every trader, you need roughly 10 support staff. You need specialised (and therefore premium) office space with raised floors for cabling and contingency measures like an uninterrupted power supply (UPS) and recorded telephone lines connected to an atomic clock. Like the fact that it is legally enforced for bank vault walls to be made of steel of a certain thickness, if you want to trade commercially, all these things are audit and legal requirements. There is also the cost of capital. When you trade, you are effectively borrowing money from the Company in order to place your positions. Some companies charge more than others for this “internal haircut” but those that charge less tend to spend more on Control (either Risk or IT), so in the end, it amounts to roughly the same figure; $1m per trader per year.
Traders can be roughly split into three categories
- Junior Traders: 1-3 years experience, usually graduates cutting their teeth.
- Senior Traders: 3 years experience upwards.
- Desk Heads: Managers who run the desk.
Salaries can be considered pre and post the Lehmans collapse, as that is when banks had to start capping their bonuses and of course basic salaries shot up as a consequence. Pre Lehmans, most salaries were just under £100k per year because it was all about the bonus. Nowadays, a Junior Trader looks for around £150-175k and a Senior Trader £200k. Desk Heads get paid around £250k.
When the UK Government issue their annual salary statistics, they do not include bonuses or the self employed, and always at the number one spot are the nation’s CEOs or Captains Of Industry. Now, look a little deeper into the definition and you will see that Directors are also included. Most traders, with the exception of Junior Traders, are at a Director level or higher. So, traders are at the top of the PAYE charts. Well done, but it does mean something more. Being in the higher tax bracket means that any bonus, even a single pound coin is then taxed at 50%.
The Company expects a certain level of performance for its investment. A Junior Trader may get away with a flat year to begin with but will then be expected to make around $2m a year, thus doubling the Company’s investment. A Senior Trader is expected to make a minimum of $5m and a Desk Head is expected to contribute to the overall desk goal. Of course, you can’t make money every year and the Company needs to squirrel away some funds for lean years, but a trading desk’s lifespan can be as short as two years. Also, it must be remembered that for every $1 made in a trade, your counterpart loses $1. By definition, 50% of the market will be losing money at any one point. I have seen Senior Traders with good track records cashed out in a matter of months, never to be seen again. In my experience, a trader starts getting heavily monitored at -$1m to -$2m and is finally “removed” if the years profit and loss (PnL) goes to -$4m. For the record, I have also seen a single trader lose $400m in a week, but that’s another story!
Here we come to the interesting part, and we need to be a bit philosophical. When the newspaper headline says “Fat Cat Traders get $1m Bonus Each”, that’s not strictly correct. Yes, the Company sends a letter saying “Well done, you’ve earned a $1m bonus”, but the first thing the trader reads is the small print. Firstly, in order to get $1m in the first place, the trader must have generated between $20m and $35m in pure profit for the Company. This is because, in general, most banks and trading companies pay out 3-5% of net profit to the trader – after costs, remember – and it’s “discretionary” (more of that in a moment). The high-end hedge funds pay more; about 12-15%, and because these traders are usually hand picked seasoned professionals, this percentage is usually stated in their contracts.
Discretionary – this is the worst word in any trader’s contract, but they don’t really have much choice about it. It means that the bonus payment is purely an option on the Company’s part. An individual trader may make $50m in a particular year, but if the guy sitting next to him loses money, or even if that loss occurs in a completely different market in a completely different country, the Company can pull the “One Team, One Dream” card and not pay anyone. Post Lehmans, this happened a lot and is another reason why basic salaries went up.
So, we’ve ascertained the amount of money needed in order to justify a possible bonus. Next is the way it is paid. As a general rule of thumb, a bonus is paid half up front and then the other half is spread over the next 2 or 3 years. The deferred part is usually paid in Company shares and is therefore performance linked. Again, One Team One Dream. Also, if the trader leaves within that deferred period, they lose it. That is why traders get “sign on” bonuses when they join a new company; the new company needs to cover the loss of deferred bonus from leaving the old company.
Let’s recap: The trader makes $26m ($25m after costs) and the company issues a $1m bonus. $500k is deferred over three years and is in the form of company shares. $500k is paid up front, but $250k goes straight to the tax man. What happens to the other $24m? Well, don’t forget the bonuses for the Desk Head and all the other Management above. Also, although considerably smaller, the 10 support staff are paid bonuses. When everyone has taken their share, the Company accountants do their magic and after various machinations the company will pay 30% corporation tax on whatever is left, which is generally very little.
So, what have I learned? Well, despite the sensationalist headlines that the media print, I feel that it is far better for society in general if traders were paid bigger bonuses. After all, 50% of any bonus goes to society in the form of tax. Controversial, I know, and I’m aware that this is an oversimplified view of a complex subject, but 50% Income Tax is better than 30% Corporation Tax any day of the week.