The secret giant of finance

0:06Pushkin. Now if you keep half an eye on the nerdier bits of financial markets, then you will have heard about a spicy little scandal in Indian stocks. Earlier this month, the regulator there tore a strip out of a trading firm called Jane Street, accusing it of a, quote, sinister scheme to manipulate the market. It also impounded over half a billion dollars of what it called illegal gains over the matter. Now, Jane Street, as you might imagine, has denied all this very firmly, saying it is beyond disappointed with what the regulator has said. It is all very much the talk of the town. And I mean, sure, this is a relatively small stock market.

0:52But today on the show, we're going to ask, what, if anything, does this episode say about how shiny new style trading firms operate? And where could it all lead? This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist here at FT Towers in London, where it's very much sun's out, guns out. This is a hot country now and we need to get used to it. Now joining me in the studio is a special guest all the way from Oslo, Robin Wigglesworth, editor of FT Alphaville and one of the authors of a recent FT big read on the Jane Street snafu.

1:33Robin, this sort of stuff is like your entire personality, right? You love this sort of nerdy stuff. Yeah, I mean if we could have a title at the FT that was chief nerdy finance correspondent, then I think that would be my dream job. So this is just like Christmas come early for you from a random pocket of finance. I mean, this is my birthday. I mean, this is stuff that I look forward to. I go to work dreaming of situations exactly like this. Listen, in Norway, this is the sort of thing that passes for like high excitement. So tell the masses what is going on here. First of all, a lot of people won't have heard of Jane Street.

2:10What is Jane Street? Well, it's a street in New York, is the succinct answer. It's a trading firm that essentially acts as what we call a market maker, mostly. So whenever you buy and sell a stock in markets, there's usually somebody who buys and sells it to you. If you want to buy a stock, then they'll find it for you and deliver it. And if you sell one, they'll find a buyer for you. For a lot of people, the only reason they will ever have heard of Jane Street is because this is where Sam Bankman-Fried got his start in finance, right? before he ended up running the big crypto exchange, FDX, and then going to prison.

2:45So this is like a story that is high finance in quite a kind of quirky little pocket that a lot of people haven't heard of. Massive stakes, huge amounts of money. What's going on here, if you can sum it up? Well, Jane Street has been accused of market manipulation by the Indian stock market regulator. And that has, frankly, opened up a whole can of worms about what stock market manipulation is, when it happens. It has thrust a light on these incredibly successful trading firms that most people don't know. But, you know, I'm making more money than the likes of Goldman Sachs and Morgan Stanley in markets.

3:22And it kind of raises questions about like how resilient markets might be to one of these major new powerhouses coming in trouble. And now we're going to find out the answer to all that. We certainly are. There's a few of these like fancy pants trading firms out there. So normally if you think of trading, you think of a big trading floor, either at an exchange or at a big investment bank. Lots of people are sort of shouting at each other and waving their arms around or like staring at massive banks of screens and pressing buttons. You know how like Airbnb is the world's biggest hotel company that doesn't have any hotels and Uber is the world's biggest taxi company that doesn't actually have any taxis.

4:01These firms are like the world's biggest trading firms that don't have any human traders or have very few comparatively actual human traders doing this stuff. Well, I mean, Jane Street has fewer traders than, let's say, a Goldman Sachs or a Morgan Stanley. These kind of banks we associate with the trading of yore. But what does differentiate Jane Street from a lot of these other sort of classic high frequency trading firms that like all technology and algos, essentially, is that they do have traders, hundreds of traders. Though they sit generally in shorts and t-shirts and they whisper very quietly whilst they do mental puzzles and math olympiads in their spare time.

4:38Yes, as do we. Oh, obviously, obviously. That's a Thursday night for me. Yes, but these are not the kind of human intensive operations that you might think of. And they're not the general population. If you think of trading, you don't think of a firm like Jane Street. But these guys are massive, right? They're huge. I mean, they've been successful for a long time. I'd say in the last half decade, they've gone gangbusters. Yeah. I mean, they went from around$2 billion of trading revenue, let's say, in 2018, 19, to now last year, they raked in over$20 billion net trading revenues in a year. That's a fair amount of cash, right?

5:16That's the equivalent of most major banks in the world. It's not far short of a Morgan Stanley or Goldman Sachs. In the first quarter of this year, in fact, Jane Street made more money in markets than Morgan Stanley and within touching distance of Goldman, which has frankly been the powerhouse of financial markets for several generations now. Yeah. So it just goes to show if you can inject yourself into just the right bit of the plumbing behind markets, there is money in them, their hills. Yeah. I mean, they've been smart and kind of successful for a while. They started off trading something called American Depository Receipts on something called the Old American Stock Exchange.

5:52Literally, they don't exist anymore. They branched out into this new product called, at the time, Exchange Traded Funds. And obviously, that became a huge successful thing for them. Which is another thing you can nerd out on all day long. Listeners, we're going to spare you. I can tell he's about to go. Robin, reel it in. Come on, man. No index funds, I promise. But so Jane Street has been like riding this incredible wave for a few years. And then all of a sudden it's really stumbled into something in India. One of the things that was really interesting to me from the piece that you were involved in that ran the other day, listeners really should check it out if you're even remotely interested in this stuff, is that the regulators have been sending it warnings for a little while, right?

6:33Saying, hey, knock it off, like knock what off? I mean, it gets obviously quite legally sensitive. And Jane Street, we should again stress, denied that the regulator ever told them to knock it off and that they didn't do it. They say they've been trying desperately to engage with the regulator, the Indian regulator, for quite some time and have just received radio silence. But what the Indian regulator is basically alleging is that in India, there's a stock market. But there's also this massive thing called the derivatives market, which is big elsewhere as well. But in India, it's like the eighth wonder of the modern world.

7:08It is insane. It is an options market so big you could see it from space. It is the great wall of options trading. It is bigger than every other market in the world combined, times a factor of three, I think, almost. Is it bigger than your ego and Rob Armstrong's ego put together? Maybe one and a half, Robin and Rob, and maybe. But it's big. It's big. But it's pretty big. Let's not get over balls. It's big. So the deal with derivatives, right? So just in the stock market, you can buy a stock and then, you know, you're effectively betting that the stock is going to go up and you hope you're going to make some money out of it.

7:46With derivatives, you can sort of bet on what the stock is going to do without necessarily owning the stock. And there are lots of good reasons why you might want to do that. If you're like hedging yourself against risks, it can just be like a conservative, normal thing to do. but you can use derivatives to make wild bets, right? And this has just been phenomenally popular in India. I mean, it's been popular for a while, but for instance, since 2020, it just went. I mean, it's not even parabolic. It is incredible. If you have a chance to see a chart, it is gobsmacking. And we've talked about, obviously, how people embrace trading, retail trading in the US, in Europe, in the lockdowns, but India just took it and just went to town.

8:28To a whole new land. And for a market maker, a trading firm like Jane Street, I mean, that's not just catnip, that's goldmine stuff. They went crazy. They thought this was incredible because also, dare I say it, like ordinary traders are not the most risk sensitive, mathematically inclined, careful people in the world. Certainly anywhere in the world. And that's frankly, especially true in India. Around the world, I think 80 percent of people lose money trading options very quickly. in India, even the regulators says it's close to 90%. Wow. But somebody has to sit on the other side. So who's going to make the money?

9:05Well, that was, to a large extent, Jane Street. Yeah. So like clever nerds doing math Olympiads, right? I can't even say it. That's how far I am from doing a math Olympiad. But when they see like charts where you have a share price going in one direction and derivatives that are based on that share price, just massively exceeding moves in the underlying asset. That is a gap that you can insert yourself in and make money, right? Yeah. So a lot of what these guys do is something called arbitrage. They see two prices that should be linked that are less linked than they should be. So you buy one security, you sell the other one.

9:42And in theory, over time, if they should be worth the same thing, you'll make money on that. And what the regulator says that Jane Street did in India was essentially they went long bought lots of Indian bank stocks, shorted Indian bank derivatives, especially options. And then once they had a massive position in options on Indian bank stocks, they then dumped all the Indian bank stocks. And because the Indian stock market is actually not very healthy, it's not very liquid, that made the value of the far larger options position much more worth. So, yeah, they lost money on buying and selling the Indian back stocks.

10:27They made way more money on those options on the other side. There's lots of things in risk management at trading firms or at banks that if you really wanted to, you could say, well, that looks and smells like market manipulation. But they would say, look, this is just either exploiting an opportunity that's open to literally anybody or actually us providing a public service in helping prices to converge and help markets to function more smoothly. I guess that's the territory that we're in here, right? So Jane Street, as you were saying, right at the top, are saying, wait, we haven't been manipulating anything.

11:06This is like a really gray area. Well, all trading normally has an impact on the market. Are you manipulating that market? If I buy a stock of Apple, realistically, it's going to have a very small impact. If I'm a big hedge fund and I buy a billion dollars worth of Apple stock, it's probably going to push the price of Apple up a little bit. But I am manipulating Apple's share price. It gets fuzzy actually quite quickly. I always call these duck rabbits, like the classic illusion. Like, is it a duck or is it a rabbit? Jane Street is saying that actually what they did was what they call index arbitrage.

11:40They took advantage of the fact that you have this massive, highly traded options market. And there's frankly, slightly decrepit, crappy actual stock market. And they made sure that those prices were more closely linked. And they happened to make lots of money doing so. I don't think they use the word crappy, but still, that's the gist here, right? That's my favorite technical word for it, at least. Now then, what are other people in the industry saying about this? Well, they're shocked. There's a whole new generation of new trading firms like Citadel Securities, Hudson River Trading, Jump Trading, Virtu, XTX, IMC.

12:18I mean, these firms are very successful. Again, you love this stuff. I love this stuff. But they're fascinating. They are kind of the ascendant force in markets today and not everybody appreciates that. And Jane Street was kind of the best of the best. In the same way that maybe Goldman Sachs was for so long kind of the apogee of Wall Street. Jane Street is where the smartest people aspire to work. It's just having a Jane Street internship on your CV is a cool, sexy thing to have these days. Whatever you want to do in the future. It's considered like the ultimate imprimatur of being a very smart person.

12:51Yes. They pay their interns more than the U.S. government pays the chair of the Federal Reserve. like interns make the equivalent of$250 ,000 a year Crikey O 'Reilly and that's more than Keir Starmer the Prime Minister of the UK as well I found out I feel like I should have paid more attention in maths yeah no I definitely should have done better in my Math Olympiads I think but the thing is Jane Street also had a pretty good reputation like I've been writing about them and their rivals and nobody even their rivals ever had any bad words to say about them except we hate those guys they're doing too well.

13:25It's annoying us. Also, the origin of this scandal is kind of interesting to me, right? Because it comes from the fact that Jane Street, correct me when I get this wrong, but they were taking a couple of former employees to court saying that they had given away secrets of Jane Street trading strategies when they went to another employer. That's broadly right, yeah? Yeah. So one of the ultimate flexes and illustrations of how kind of badass Jane Street was at their peak or are now is that they didn't have non-competes. Most people in the finance industry tie people up in all sorts of very difficult contracts.

13:59You can't just easily leave for a rival. But they were so cool and they paid so well and it was such a great place. They just, as a flex, didn't really have this. But as they've grown, they have occasionally had people retire. Jane Street partners were famous for retiring in their 30s because they had generational wealth. I know. But they actually had somebody leave them for a hedge fund, Millennium Management. and apparently Jane Street alleged that they took with them the secrets to this very profitable Indian options trade and they sued Millennium and then it emerged in the lawsuit that this was around Indian options and that was what made the Indian regulator sit up and take notice.

14:39Well, I bet they're regretting trying to sue those guys, right? Yes, I think this is quite possibly the most expensive, crazy Barbra Streisand effect I've ever seen, essentially. What does this all mean and where does it lead? Does it put other high-speed trading shops or sort of new style trading shops off being active in India or in arbitrage strategies? Not arbitrage strategies overall. Everybody says, you know, with a mix of disbelief and schadenfreude that, you know, we can't believe what James Freed did here. We won't condemn them. They're smart people. But this looks bad. Do you think they're thinking this could be us tomorrow?

15:18It's possible that you run a rule over a whole bunch of stuff that we do that we think is benign or even helpful. And a regulator on a mission could try and describe it as manipulation. Yeah. Well, the thing is, because it is a duck rabbit situation in many cases, I mean, this one, frankly, doesn't look great. We'll see Jane Street's defense eventually, I suspect. But they all say we don't do this. We're not worried about that. But 20 years ago, trading firms, especially high-frequency trading firms, it became this popular kind of bogeyman. They were the flash boys. And they'd finally kind of gotten over basically a decade of being blamed for everything that went wrong in markets.

15:56So people are kind of maybe happy seeing a big rival like James Creek getting humbled. But some of them are also wary that this might lead to a broader sort of regulatory scrutiny. They're all very confident that they won't find anything bad on their patch and what they're doing. But obviously regulators crawling up every crevice is not a fun thing. No. Do normal people need to worry about this? What are the chances that this could lead to dislocations in markets, do you think? Well, it's a good question just because Jane Street is so humongous. I mean, they trade trillions of dollars a day almost.

16:34But like, I mean, they are one of the biggest market makers in the United States. Like one in 10 of every share that trades in the United States, they traded by Jane Street. there's only one firm making them that's Citadel Securities they are huge in Europe they're huge in exchange traded funds they're even big in bonds these days they're big in almost every market so I don't want to be sound too dismissive of the rest but I think like given that this would be a very sort of idiosyncratic downfall if it ever came to that there are enough rivals that would gladly see the back of Jane Street that would step in and pick up everything so actually this wouldn't be a downfall happen by a big financial catastrophe.

17:13No, no, no. So I think this is something that touch wood probably won't lead to any sort of major issues, if it leads to major issues at James Street, which obviously is still very unclear. So in the meantime, it's just kind of like Real Housewives of downtown Manhattan, right? It's just kind of the most kind of glorious popcorn-filled kind of soap opera that you can possibly imagine in, just to restate, a very nerdy part of finance. Yeah, but it's very nerd, but insanely successful. I mean, these guys were making more money than God. I mean, Jane Street made more money than Citadel. They are the highest earners.

17:50And I think that's why there's so much interest, right? I mean, everybody likes really smart, successful people occasionally face plant, right? It's just highly amusing, even if you have no bone in the fight. And it's just, for a nerd like me, it's just really interesting because it does go to the heart of what these firms are, how they operate. What they do, what are the grey zones, how might regulators respond, and what could the fallout from that be more broadly? And we're finally going to maybe see that now in real life. So for you, Robin, like you live and breathe this stuff, you love this stuff.

18:22Is this going to be your favourite story of the year, hands down? Well, we had the old tragic comedy around Liberation Day, right? Liquidation Day, as some people call it, the penguins, the poor penguins getting sanctioned. That was pretty amazing. But this one is up there. least top three and we'll see how how the year goes good stuff listeners i hope you have enjoyed this immersion in the world of robin wigglesworth we are going to be back in one second with long short okie dokie it's time for long short that part of the show where we go long a thing we love or short a thing we hate robin how do you remember that this is a part of the show I have now.

19:12Okay, let me go first. I am short bedbugs. So somebody who I know very well, I'm not going to say who it is, was staying in a hotel last night and they were like in bed and then they were like, oh, what's that over there? Oh, what's that over there? Bedbugs! No! I just I think they should burn everything they own and not take it back to their home. But it's been like a highly unpleasant drama. Let's hope it's a one off. What have you got? I'm tempted. I had once bedbugs in New York and I am still traumatized. You said this now and I literally brought I mean, it's cold shivers almost. It was maybe I've been had a very lucky sheltered life, but it was one of the most traumatic experiences.

20:01It was also with a newborn baby. Oh, no, no. But I can't go double short that, of course. So, yes, I guess I'm feeling in a short frame of mind. So I guess micro strategy. I'm sure it's been short on the show. Heaven knows I've tried this before, Robin. Did you not know the whole story? Yeah, but eventually I'll get proven right or some of one of us will. And maybe I'm the one that kind of finally manifests this into reality. Listen, learn from me, like betting against this company that just buys Bitcoin and that's all that it does. Like the doubters never win, man. But now they're literally issuing the reason why for me, my latest sort of short thesis here, they're literally borrowing money to pay like the money on some of the other money they've borrowed earlier.

20:46Like obviously because it's like a Bitcoin buying machine built on a crappy software company that doesn't really generate any money. They've borrowed all this money. They have to pay on that. So they have to borrow more money to pay the early investors. And I'm not going to say what that is normally called, but like, I mean, at some point this, the music has to stop. Robin, I'm just here to tell you, I got thoroughly humiliated trying to short this thing. So I am, I'm just out of micro strategy or strategy as it's called now. But you do you. And listeners, if you've got thoughts about strategy and you'd like to tell Robin, he's an idiot.

21:17Robin.wigglesworth at ft.com. Fill your boots. Now, we're going to be back in your ears in just a couple of days. So listen up then. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn and Natalie Sadler. FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.

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