Fed, BoE probe bank exposure to trading firms after Jane Street loss - report

The Bank of England and the U.S. Federal Reserve are intensifying their examination of banks' financial ties to major trading firms following significant losses incurred by Jane Street, a New York-based trading firm. According to the Financial Times, regulators are questioning global banks about their financial exposure to trading entities and market makers, including Jane Street and Ken Griffin's Citadel Securities.

The watchdogs have been focusing on understanding banks' exposure to non-bank financial intermediaries, such as private credit providers, but have escalated their efforts in the wake of Jane Street's substantial losses. Jane Street reported a staggering $15 billion loss in July, which was partly attributed to losses from an AI-focused hedge fund, Situational Awareness, in which Jane Street had invested.

Despite posting $40 billion in net trading revenues early in August, the size of the loss indicates that Jane Street took on far more risk than a typical market maker. The firm, which generated $40 billion in revenue last year, is the world's most profitable trading firm. Specialists like Jane Street, Citadel Securities, Susquehanna, and Hudson River Trading have seen rapid growth since banks distanced themselves from proprietary trading following the 2008 financial crisis.

Many of these firms started as market makers but have since expanded their proprietary trading operations, making directional bets with their own capital. Unlike hedge funds, these trading firms typically manage only the capital of their founders and employees. Banks provide market access to these trading firms and hedge funds through prime brokerage, extending leverage and financing equity trades, lending against bonds, and clearing derivatives.

If regulators deem banks to be taking on excessive risk, they can require them to hold more high-quality liquid assets. The Bank of England has also been looking into the rapid expansion of financing Asian equities by London-based prime brokers, particularly in response to the extraordinary gains of AI-driven stocks such as SK Hynix.