Goldman Currency-Trading Definition Shows Disclosure GapMichael J. Moore
What’s the difference between trading currency products and currency trading? More than $1 billion, according to Goldman Sachs Group Inc.
The investment bank said last week that it didn’t have a third-quarter loss in currency trading. That followed a report by Reuters on Goldman Sachs’s Nov. 7 Securities and Exchange Commission filing, which shows a $1.32 billion loss from market-making in currency products.
The disconnect stems from the fact that the biggest U.S. banks don’t provide a revenue breakdown for units that make up their equity- and fixed-income trading divisions, which reap more than $70 billion a year. An SEC requirement that banks give some specifics on those businesses resulted in disclosures that firms such as Goldman Sachs, which gets more than half its revenue from trading, said lack meaningful context.
“If you’re trying to figure out the profitability of different lines of business, I don’t know how you effectively do that,” said Edward Siedle, a former SEC attorney and president of Ocean Ridge, Florida-based Benchmark Financial Services Inc. “The commission needs to be careful not to require a disclosure scheme that is just as likely to be misleading as it is to be revealing,”
John Nester, an SEC spokesman, and Michael DuVally at New York-based Goldman Sachs declined to comment about whether the disclosures could change.
Goldman Sachs tells investors in quarterly earnings reports how much revenue it makes from trading “fixed income, currency and commodities” without giving specifics about the components. That line produced $6.93 billion in the first nine months of this year, 27 percent of the firm’s total revenue.
The closest thing that investors get to a breakdown is in 10-Q filings that Goldman Sachs makes public a few weeks after reporting results. The filings disclose “gains and losses from market-making and other principal transactions” and include figures for interest rates, credit, currencies, commodities as well as equities and “other.”
Those gains and losses “are not representative of the manner in which the firm manages its business activities,” Goldman Sachs says in its filings.
The SEC asked Goldman Sachs in May to disclose how much units such as mortgages and commodities contribute to trading revenue to give investors more clarity on how the firm makes most of its money. The company said it would give more qualitative detail on the units, and the SEC completed its review. Goldman Sachs also replied that it already had provided product-level figures, as it has done since at least 2009.
Those disclosures often provide investors with information that conflicts with the performance of the bank’s units. That’s because the data may include gains or losses from a product that was part of a larger trade, such as when a commodity bet is hedged with a currency trade. The figures also don’t include commissions or interest income related to the trades.
The first quarter of this year included a $1.14 billion loss in interest-rate products, according to a May 9 filing, while the company said in an earnings conference call that the rates business had a positive quarter reflecting “higher activity levels.”
For the third quarter of 2010, Goldman Sachs reported that currency products produced a $4.59 billion loss, swinging from positive revenue of $3.6 billion in the previous quarter. Then-Chief Financial Officer David Viniar said the firm’s currency business produced higher revenue in the third quarter than in the second.
The incongruities largely resulted from the fact that products in other units are hedged against fluctuations in interest rates and currencies. Those two products have moved mostly in opposite directions, with one of the two posting a loss and the other a gain in 14 of the past 15 quarters.
That inverse relationship makes it difficult to glean much information from product-specific disclosures, said Roger Freeman, a Barclays Plc analyst who said he relies more on Goldman Sachs’s commentary about performance.
“The currency trading and rates businesses are very closely linked; a big driver of the exchange rates is a function of relative interest rates across regions,” Freeman said. That leads to questions like, “Was it a rates trade where the revenue was driven more by the underlying currency move or the move in the rates?” he said.
Investment banks have resisted detailing sources of trading revenue to avoid revealing strategies or positions to competitors. Instead, many try to provide investors with descriptive assessments of their businesses, such as whether they benefited from “higher client activity” or suffered from “low volatility.”
“Regulators shouldn’t pay too much attention to whining from the industry that increased disclosure is going to hurt them competitively,” Siedle said. “Even if it were true, if all the companies in that industry were required to do the same, then the detrimental impact on any one of them has been negated.”
Credit Suisse Group AG is an exception in that it details what portion of its fixed-income revenue comes from commodities, emerging markets, securitized products, credit and so-called macro, which includes interest rates and currencies.
In 2009, Coalition Ltd., an industry analytics firm that counts the largest banks as clients, started publishing estimates of the breakdown of the collective trading revenue for the top 10 global investment banks.
Freeman said he wants banks to reveal more data about their fixed-income trading. Disclosures of revenue by product would help investors understand whether differences in performance between firms was driven by the mix of businesses or by execution in those units, he said.
Regulators still must attempt to limit subjectivity in any new requirements, Freeman said. Fixed-income markets are often closely linked, forcing banks to decide where revenue from some trades should be recorded, he said.
“If it’s not some sort of standardized definition, then you’ve got a bunch of new data that may not be useful to anyone,” he said. “I can appreciate why the firms wouldn’t want to do it.”