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Trading losses: How to cover a black hole

It's every risk manager's worst nightmare. One trader amasses enough losses to bring the bank down, as Nick Leeson did with Barings, or forces a wholesale retrenchment, as happened at NatWest Markets following the discovery of Kyriacos Papouis's mispricings.

There is only so much a bank can do to prevent something like this happening. And once rogue traders elude the in-house regulations, the only option is to hope that the bank can swallow the loss.

Insurance has rarely helped much. Some policies already exist to cover fraud and professional indemnity, such as when a bank is sued by a client, but these would hardly ever apply to losses caused by unauthorized trading. This has caused senior bankers some sleepless nights. "We'd had several of our clients asking us if there was an insurance market capable of providing catastrophe cover against rogue traders, especially since Barings," says John Sanderson, deputy chairman, global financial risk at insurance brokers Willis Faber & Dumas.

Although some banks, JP Morgan especially, have made some changes to their fidelity policies to take account of the risks of unauthorized trading, there has been no specific policy to deal with the potentially catastrophic losses such actions might cause.

Until now. Executives at Lloyd's underwriter SVB Syndicates have recently announced the launch of an unauthorized-trading insurance policy to cover banks for any losses from trades which are concealed or falsely recorded by individual traders.

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