Everyone remembers Mikhail Bulgakov’s book about the dog that becomes a man. Sharik is not exactly a sweet dog, but it’s only when he becomes the human Polygraph Polygraphovich that his worst impulses are made real.
Bulgakov was dumping on communism and the attempt to transform a reprobate like Sharik into an intellectual overnight. But another part of the story could be described as a response to incentives.
Sharik behaves one way as a stray, more arrogantly as the pampered pet of Professor Preobrazhensky, and then still another way as a human. It’s like the opposite of what that Spartan guy Agesilaus said. Sometimes it’s the place that changes people, not the people that change the place.
This is a long-winded way of saying that, in the CFD industry, there is a lot of money floating around. And often when a lot of money is floating around, it can create incentive structures that lead people to behave in a certain way.
Since I started writing this email, I have been fed the odd, intermittent rumour that some people working on dealing desks occasionally receive payments that are outside the confines of their normal remuneration packages. And in return for these payments, the flow that the broker they are working for receives is directed to the company that is giving them that payment.
Actually finding examples of this behaviour is going to be almost impossible for me. You may be surprised by this but saying, ‘Hello, do you take kickbacks so that you send flow to a specific LP?’ is not a question that many people will enjoy being asked.
However, while no dealing desk team member we spoke to had been offered money directly, every single one believed that it does happen. “It is rife” was one phrase used to describe the phenomenon.
In terms of actual examples, one reader believed that an old boss had been engaging in this practice. Someone who works at a liquidity provider also told us an interesting story.
A couple of years ago, they were engaged by a broker owner to try to see why performance on their trading desk seemed off. This person then found a feed they believed was the reason for the poor performance. They plugged their feed in and were able to do a comparison, showing their hypothetical performance would be better.
But along the way, the person in charge of dealing at this company seemed to go out of their way to stonewall, stymie, and slow the progress of moving away from the incumbent provider. Even after the LP executive had shown strong evidence of the other provider’s poor performance, the dealing head seemed to do everything in their power to stop them from migrating.
As to why this happens, the answer seems fairly obvious. One reader noted that senior dealing staff and some small and mid-size brokers can be paid salaries that are not exactly ‘bad’, but are also not gargantuan.
“It’s not abnormal that a senior dealer is being paid €6,000 or €7,000,” the reader said. “So imagine if you’re a liquidity provider and you can make 5x that amount from their company per month. You can double the dealer’s salary by paying them and still walk away with a massive amount of revenue that is very profitable for you.”
I would add to this that the push to do this must be made more acute by the dealer’s position. Apart from perhaps the finance department, no one else is in a better spot to see how a company is performing. If you believe you are being underpaid and can see the huge sums of money a firm is making, then it may mean you feel an even stronger desire to engage in the behaviour we’ve just described.
Of course, this is arguably all theoretical and one point that several people I spoke to noted was that this would show up in results. I don’t think this is true.
Firstly, it implies that the LP paying extra fees is necessarily a bad one. That might be true. It might not. To top that off, liquidity honestly seems like a fairly commoditized product. Everyone is ultimately offering something quite similar, meaning it would not be obvious that the LP being used was ‘bad’.
Perhaps more importantly, and this was also highlighted by one reader, many owners and senior stakeholders at brokers don’t have the time and/or knowledge to even realise this is happening. To give some different examples, I am aware of two incidents in which executives in operational roles in the UK and Malaysia were able to cream off hundreds of thousands of pounds in cash, without anyone at the firm realising for a long period of time.
Now imagine that, for a broker facing a specific LP, there would be no ‘lost’ money like in these incidents, just the potential that more revenue could have been generated by facing a different counterparty. In other words, if you make $1m and $100,000 disappears, you will eventually notice it. If you make $1m but could have made $1.05m, then it’s much harder to see that something is wrong.
So what to do in this scenario? There are two points. Firstly, I think of visiting my mother-in-law’s relatives in a country where this kind of activity is commonplace. Paying bakshish for them is kind of like going to the bathroom or enjoying a hearty meal in the evening. It’s just a fact of life and not something you think too much about. My point being that many people may not see this as ‘super evil’ in the same way that some readers may feel inclined to.
Secondly, I’m reminded of Elon Musk recently complaining about some politicians being bought off by wealthy people so they’d pass specific legislation. Well, my friend, you’re the richest guy in the world. I’ve got a crazy idea for you.
