On UBS’ unauthorised trading loss
Unsurprisingly, the discovery of $2.3bn in losses at UBS caused by unauthorised trading last week continues to make headlines. The similarities with the Kerviel case at SocGen over three years ago are striking. Both worked on the same desk, seem to have used a similar system to hide their activity and worked in the back-office before becoming traders. That such an incident occurred again raises questions and implications both at the level of an individual institution and for the wider industry.
Details are still sketchy at this stage, but it certainly seems that the losses should have been identified by back office processes, whether by reconciling cash positions, monitoring cancelled trades, margin calls, funding etc. Kid Dynamite’s post on this is instructive reading. Especially in the wake of the Kerviel affair it’s puzzling that controls appear to have failed to this extent.
UBS’ investment bank has been in more or less turmoil pretty much for the entire period over which the trades occurred, so perhaps personnel changes and turnover resulted in less focus on these control frameworks, or attention was diverted to areas such as liquidity risk and capital management at the expense of operational risk. In either case, this event should cause banks to conduct emergency exercises in reviewing their procedures and tightening the controls between front- and back-office—again.
Among the less obvious conclusions, John Hempton writes that investment banks should never hire employees from their back-office for front-office positions, since they know the systems too well and could easily circumvent controls. Although it resembles the “security through obscurity” argument perhaps a bit too much, this does make sense, not only in terms of systems knowledge but also the social capital the new trader would have with the remaining back office colleagues. However, the possibility of joining the front office arguably attracts worthwhile people to the back office that may otherwise not bother. The bottom line remains that the systems need to be robust enough to cope with any attempt at fraud, however skilled or informed, and clearly work remains to be done here.
As to the wider industry, the event was inevitably seized upon to justify and reinforce various regulatory attempts to restrain investment banking activities within a universal bank. In recent months, financial industry groups had been arguing against too strict regulations, it seems clear now that this battle is lost. Politicians will be even less inclined to cut banks some slack on the implementation of ringfencing etc., and now that the clock could be ticking for UBS’ investment bank, the model of the universal bank is under more pressure than ever.
