Rogue trading is a consequence of investment banks over-encouraging high-risk activities, according to Gordon Nixon, CEO of the Royal Bank of Canada.
“The underlying cause of these types of incidents is a culture of profit making,” said Nixon at the Sibos banking conference in Toronto, who nevertheless asserted that attitudes to risk were “getting better” as banks progressed through a period of transition. “Culture is extremely important,” he said. “Risk, integrity and ethics must be ingrained and too often it is not.”
Last week, London-based UBS trader Kweku Adoboli was arrested after it was revealed he had lost the company $2.3 billion in unauthorised trades.
“As bankers, we like to think risk standards are strong enough but whenever something like this happens, you tend to take stock and readdress your assumptions.”
Nixon said bank culture needed to fix more firmly on customers.
“You cannot put enough emphasis on the management team and you need to compensate them in the right fashion,” he said. “Do not promote and reward just on the ability to make money but also on acting appropriately.” He also insisted risk management must start at the front, with business managers, sales and traders.
Of the recent incidents of rogue trading, Nixon noted that both had happened at “unusual levels in the organisation” – both Adoboli at UBS and Jérôme Kerviel at Société Générale in 2008 were at “middle or junior levels” rather than star traders.
Adoboli – who worked in the bank's global synthetic equity business in London – has been charged by UK authorities with fraud by abuse of position. UBS said the loss resulted from unauthorised speculative trading in S&P 500, DAX, and EURO STOXX index futures.
Adoboli – who had considerable back office experience as a trade support analyst before becoming director of exchange-traded funds (ETFs) at the bank's Delta One desk – took unauthorised positions while executing normal business flow with a large global equity trading house as part of a properly hedged portfolio.
“It seems the trader developed his skills in the back office and this in itself raises a certain amount of risk, given his detailed knowledge of how the systems worked,” said one London lawyer who wished not to be named. “This risk can be managed but it is possible that it was not identified.”
Masoud Zabeti, partner and head of finance and banking at law firm Mishcon de Reya, said that the difficulties of imposing real-time monitoring of positions meant a determined rogue trader can invariably find a way through the strictest of policies, procedures and controls.
“This incident will bolster arguments from Swiss politicians calling for tougher bank regulation, which includes the separation of the retail and investment arms of banks,” said Zabeti.
The true magnitude of the risk exposure was distorted because the positions had been offset with fictitious, forward-settling, cash ETF positions, allegedly executed by the trader, UBS has disclosed. These fictitious trades concealed the fact that the index futures trades violated UBS's risk limits.
“This raises the need to scrutinse systems and controls. Inevitably, when you are dealing with bright people who are encouraged to take risks, you must have the controls in place,” said Peter Snowdon, a partner in the financial services group at London law firm Norton Rose.
Adoboli came clean to his bosses on 14 September when UBS control functions were reviewing his positions.
“The legal repercussions will be significant and far-reaching, beginning with a criminal investigation – likely to be lead by the Serious Fraud Office (SFO) – and regulatory investigations,” said Mishcon's Zabeti, who does not expect the incident to lead to any changes in regulation. “Although, it will no doubt be taken into account as part of the overall and ongoing regulatory reviews. “The Swiss and British financial watchdogs will now focus in on UBS and its internal systems and controls.”
The Swiss Financial Market Supervisory Authority (FINMA) and the UK Financial Services Authority are launching comprehensive independent investigations into the events surrounding the scandal.
FINMA said its investigation would be conducted by an independent third party and would focus on the details of the unauthorised trading activity, the control failures which permitted the activity to remain undetected, and will include an assessment of the overall strength of UBS's controls to prevent unauthorised or fraudulent trading activity in its investment bank.