Banks make belated compliance push to combat market abuses

Simon Watkins
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As more financial scandals continue to emerge, regulators and banks are hoping technology and new internal controls will allow them to get to grips with the rogues. Trading floors might never be the same again.

It has been a couple of turbulent years, with financial markets making headlines for all the wrong reasons: in 2012 UBSs Kweku Adoboli was imprisoned for seven years having racked up a $2.3 billion loss by amassing more than $8 billion in unauthorised equity index futures positions (and hiding them with fake hedges), while a group of London-based traders were caught colluding to fix the London InterBank Offered Rate ( Libor).

And still it seems the financial markets appear to have learned little from these past mistakes: JPMorgan has been fined $920 million after traders in its chief investment office in London were found to have priced a derivatives portfolio to reduce reported losses of about $6.2 billion, and another group of traders have been accused of persistently colluding to fix the price of currencies during the 4pm London Fix.

Is anything changing in markets systems, processes, even psychology to minimize this type of market abuse, either by individuals or by institutions?

In truth, says Philip Lieberman, president and CEO of privileged identity management and security software firm Lieberman Software in Los Angeles, every single system that the financial industry needs to combat rogue trading and/or wider market abuses is already available, and has been for some considerable time.

The reason why none of these have been utilised effectively, he adds, is because of a basic calculation done by trading organisations around the world: subtract the fines from rogue trading activities from the costs of putting in all of the necessary systems.

Indeed, it is apposite to note that some two years before Adoboli wreaked havoc on the bank, UBS was fined a record £8 million by the UK Financial Services Authority (FSA) for a string of systems and controls failures that allowed employees in its wealth management division to carry out unauthorised trades on 39 client accounts between January 2006 and December 2007.

The costs to banks of total control, however, could be prohibitive: any re-alignment of its internal security and compliance systems would require a complete strip-down and rebuilding of all systems at all operational levels across the board and around the globe.

Yet such measures would add up to less than 0.01% of an average banks revenue for a year, says Martin Porter, director of sales at b-next, a market abuse surveillance, insider dealing and compliance software solutions company in London.

Although the top-line cost of the fines to many big banks may be moderate compared to broad market capitalization, the corollary costs associated with such regulatory censures are likely to be much greater, says Jeremy Stretch, head of currency strategy for CIBC in London.

A bank could be faced with issues associated with altering systems and procedures, perhaps, together with extra management costs; all of these micro-risks might have a much bigger macro-fallout, he adds.

The level of disruption, adds Lieberman, is particularly acute for the many banks that have grown in the last decade through mergers and acquisition a textbook example being Salomon Brothers hooking up with Smith Barney, which was then subsumed into Citigroup after it had merged with Travelers Group.

There are many cases where one set of systems are just bolted on to another and another and so on, and you have a sort of Gordian Knot of technology remaining, adds Lieberman.

However, in the last year or so there has been a change in attitude by banks, says Shaun Mathieson, fraud and financial crimes consultant at business analytics and intelligence software company SAS UK & Ireland. Now, he says, they want to stay ahead of the regulatory curve.

Market abuse is increasingly viewed as a risk to reputation and the bottom line, rather than simply being a box ticking exercise to appease the regulators, he adds. Firms are starting to leverage technological innovation to increase visibility of what is happening on the trading floor; an exercise that brings with it multiple benefits.

Indeed, the result of the activities of Jérôme Kerviel who was assigned to arbitrage price discrepancies between equity derivatives and cash equity prices activities at Société Générale and who wound up losing around €4.9 billion was a concomitant drying up of trading facilities with many counterparties for some time even before its problems became public knowledge.

Only some time after this did these questions snowball into rumours about other institutions exposure to questionable derivatives positions, speculation that exacerbated the severity of the credit crunch when it emerged in 2007/08.


Additionally, says Jane Foley, senior FX strategist for Rabobank in London, there are broad-based regulatory measures coming in at a national and international level that trading organizations have no choice but to implement to one degree or another.

The global financial crisis provided a spur to legislative changes to tighten up supervision of the markets, and banks have been looking to effect improvements in this regard since then.