Risk managers lack tools to monitor rogue trading

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By:
Lianna Brinded, Nathan Collins
Published on:

UBS rogue trading scandal most likely occurred due to the lack of risk management tools needed to monitor trades between bank silos, says operational risk expert.

The $2.3 billion UBS lost in a rogue trading scandal in September was most likely caused by a lack of focus and a lack of tools needed to monitor trading risk between bank silos, says Wolfgang Fabisch, CEO and co-founder of b-next and a 25-year veteran of operational risk.

The recent bout of market volatility across equities and other asset classes has generated a large number of transactions for a bank to process, exacerbating any weaknesses in existing risk management processes, says Fabisch. This is why UBS’ rogue trader was able to conduct a large amount of unauthorised trades for a substantial length of time.

“The market is extremely volatile and [during these times] some banks are having around four times as many transactions as normal,” says Fabisch. “Fraudulent actions often move between silos as risk managers do not have the tools in place to monitor transactions moving between silos.”

Kweku Adoboli , the 31-year-old charged with fraud and false accounting at UBS, has been remanded in custody until 20 October over allegations of a number of unauthorised trades on S&P500, DAX and Eurostoxx 500 futures over the last three months. Adoboli faces two charges of false accounting, related to exchange traded funds, and two charges of fraud.

UBS has revealed that the damage could result in a loss for the third quarter of 2011. It has also said that no client positions were affected and that the positions were not in themselves extraordinary, rather they were taken within the normal business flow of a global equity trading house as part of a properly hedged portfolio.

On September 25, Oswald Grübel resigned as CEO of UBS. Media reports cited a clash with the board, which refused to back his plans to overhaul the bank’s risk management strategy and corporate governance.

Fabisch notes that the necessity of effective risk management does not always resonate with the boards that direct the banks, and suggests that not enough funding is directed towards this area of operations.

“There is perhaps not enough understanding among the boards of directors of the kind of risks that need to be managed, and cost-cutting has led to a reduction in funding for compliance and risk management,” says Fabisch.

Fabisch suggests that the problem is compounded by a situation in which risk management jobs are less well paid than trading positions.

“Increasing the pay and prospects for promotion for risk managers would incentivise the most able candidates to take those positions,” he says.

Grübel’s departure does not bode well for the Swiss bank.

Before the sub-prime crisis, UBS had had a strong track record in risk management, an important strength for its private banking and wealth management divisions.

However that reputation quickly evaporated as the extent of UBS’ losses were revealed in 2007 and 2008. UBS admitted to structural failings in risk management in a report requested in April 2008 by the Swiss Federal Banking Commission.

Quarter after quarter of new outflows from wealth management clients followed, leading to Grübel, ex-chief of Credit Suisse, being brought out of retirement to run his former competitor.

Grübel has spent two and a half years trying to redeem UBS’ reputation – client business recorded net inflows again last year – but this rogue trading scandal will undo most of that effort.

Adding to embarrassment at UBS is Euromoney’s revelation last week that the bank’s operational risk unit used a database of case studies of rogue-trader events to help prevent one of its own.

The database would have included the actions of rogue trader Jérôme Kerviel, who cost Société Générale €4.9 billion in January 2008. But it seems that any increased awareness of the risks has dissipated in the intervening three years.

“There was more awareness for around 12 months,” notes Fabisch, “but little has been put in place. Banks are looking for the perfect system, but no such system exists – they need to implement the imperfect systems that are actually possible.”