- Goldman Sachs is moving away from a practice of judging the profitability of individual trades in favor of a longer-term approach to client relationships, according to CFO Stephen Scherr.
- The policy breaks from the one championed by the prior management team and ex-CFO Harvey Schwartz, who touted a tool in November 2014 that gave traders an ability to look at the profitability of each potential trade.
- The tool has been blamed for encouraging traders to focus on the short term and ignore client relationships and for weakening the firm’s trading franchise.
The David Solomon era has officially begun for Goldman Sachs’s beleaguered trading division.
Stephen Scherr, Goldman Sachs’s finance chief, drew a line earlier today under the company’s prior management team when he said the bank would move away from judging the profitability of single trades in favor of taking a broader approach to clients.
"Through our One Goldman Sachs initiative, we aim to shift focus away from per trade returns, taking a more holistic approach to client relationships," Scherr said.
On the face of it, the comment doesn’t seem all that controversial. But it rolls back a policy and a technology tool that was once a point of pride at Goldman, but which would later be blamed for encouraging traders to focus on short-term thinking to the detriment of long standing relationships.
Under CEO Lloyd Blankfein, Goldman developed a model to measure the profitability of each potential trade. With higher capital standards buffeting the industry, the idea was that it would give traders a way to determine whether an individual trade was going to hurt the profitability of their own business or that of the firm.
In November 2014, Goldman’s then-finance chief Harvey Schwartz gave a presentation about how the firm thought about using its precious capital. In his remarks, he told them about the tool which had by then been rolled out division wide.
"We developed a capital allocation tool," Schwartz said. "This software captures earnings-related information for our businesses and calculates the various capital requirements that we’re subject to. It provides the ability to have a top-down perspective for senior management and a bottom-up assessment for our business heads, right down to the CUSIP level."
Made over months and years, the thinking went, the analysis should lead to higher returns. And Goldman has managed to maintain higher returns than many peers.
Over the subsequent years, however, the model got blamed for encouraging Goldman traders to forego smaller less profitable trades even in cases where it would have served an important client.
Scherr’s comment might be the first time Goldman has admitted publicly that the old model didn’t work.
Internally, its limitations have been well known. In April 2017, trading chief Pablo Salame held an employee town hall where he implored them to "Just Add Butter," a rallying cry he coined to encourage staff to look at the overall client relationship rather than just the trade in front of them. Salame got the saying emblazoned on baseball caps.
Many traders said his speech was at least an internal admission that the capital allocation model had incentivized employees to reject smaller trades. Salame and the company declined to comment.
Scherr and Solomon, and the current securities division leadership team of Ashok Varadhan, Marty Chavez and Jim Esposito, are now trying to undo that damage.
Their model is much more of an investment banking approach where the bank woos clients with advice and analysis months or years before winning a merger mandate or a debt underwriting. Using a similar model in sales and trading might mean doing small, unprofitable trades for a client for months or years so that when the client has a big trade to get done, it’ll think of Goldman.
"We will continue to undertake the same detailed assessment of the economics and risks of each trade," Scherr said in a statement to Business Insider. "But we are now widening the lens through which we evaluate transactions to also take into account our broader engagement with each client.”
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