Reports that another rogue trader has been unearthed serve to remind us of just how easy it seems to be for a con man to get the better of a giant investment bank. UBS, the Swiss bank, lost around $2bn in unauthorised deals it said this morning. At the same time, police in London arrested Kweku Adoboli from UBS' ironically named Delta One trading desk; Delta One desks focus on hedging for customers, and are by nature relatively low risk.
The case resonates after a number of similar high-profile rogues were caught and prosecuted. Most recently in January 2008 rogue trader Jerome Kerviel (like his predecessor Nick Leeson of Barings Bank fame) woke the world up to the fact that trading without proper risk controls and supervisory oversight can lead to unintended consequences. In that case the consequences were massive losses (approximately $6bn) for Société Générale, and all because Kerviel had knowledge of and abused risk management systems at the bank to hide losses.
In UBS' case it transpires that the alleged culprit, 31-year-old Kweku Adoboli, was a trade support analyst prior to his becoming a trader. Trade support analysts are in charge of looking after the bank's electronic trading and post-trade platforms. Deja vu all over again...
It is very worrying that such rogue trading can still occur, and strong questions need to be asked of UBS's risk controls and processes. Internal risk controls need to be fluid, able to change with the pace and behaviour of the market and internal trading patterns. They are not something that a financial firm can take for granted or leave to run unchecked.
It is not only rogues and scoundrels that banks need to be aware of. Trading positions that push firms beyond a safe risk threshold are a classic problem. Trading algorithms can go out of control, like one of Deutsche Bank’s in Japan that went wild in June 2010, going into an infinite loop and taking out a $183 billion stock position. Intentional market manipulation - by traders or algorithms - is also an issue.
Detection of criminal fraud or market abuse is something that must happen in real-time before any unauthorised trading has a chance to lose a firm money or move the market. There are a number of best practices that can be used to mitigate these possible problems. Pre-trade risk management is paramount, with trading limits specified and checked in real-time, while internal controls should also be monitored for possible manipulation, again in real-time. Either way, it’s clear that without adequate internal monitoring and detection of key parameters like position limits, any amount of monitoring at the firewall will be meaningless.
The good news is that technology does exist in the form of real-time transaction monitoring and surveillance solutions that analyse data transactions in flight. Building a real-time risk firewall into your algorithmic trading environment would stop anomalous trades from getting to trading venues. These anomalous trades might be human- or computer-generated, so real-time risk monitoring is an effective method of protection.
Today's incessant drive for profits often fuels the taking of excessive risk and hiding losses. This moral hazard risk is the most dangerous kind of risk, and financial institutions need to start looking inward to improve standards, over and above the demands of current regulation. Otherwise there will continue to be more losses, even greater than those suffered by UBS today.
Richard Bentley is Industry Vice-President, Banking & Capital Markets, at Progress Software
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