Friday, September 16, 2011

New City Trader Scandal

Well, why are we so surprised? It was only a question of time before another city gambler stepped forward to claim the title of greater fool! I use the word ‘gambler’ deliberately, because that is what these people are. I mean the people who throng the city desks engaging in financial trading, whether client-focused or proprietary. Theirs is a gambling mentality, and their liabilities are magnified exponentially by the very instruments they adopt.

Derivatives instruments are fundamentally risk-limiters, used to manage and mitigate risks. When you reverse their polarity, and put them in the hands of people who are remunerated by the amount of money they can make for their institutions, speculating on the world’s markets and using instruments to leverage their exposure to potential gain, and you have a recipe for disaster.

But we have known this for a long time. Nick Leeson, 1995, Yasuo Hamanaka 1996, John Rusnak, 2002, Jerome Kerviel, 2008, all of them lessons in how and where the regulators and the Compliance departments got it so fatally wrong.

Regulatory agencies have demanded greater and tougher surveillance systems and controls to manage these risks. Daily reporting of exposed positions to the regulators is mandated, but nothing seems able to identify these traders effectively, until the problems burst open, with the concomitant losses matched only by the red faces at all levels of control.

Yet, these problems do not need to take management by surprise.

Northland Solutions Ltd, now owned by Thompson Reuters have long been able to offer a transaction monitoring tool which runs a daily surveillance function of every trader in any trading department. The tool will monitor their build-up of open positions, at what time, in which market and at what price; it will monitor when specific positions are closed, and at what price; it will closely track position limits being reached, where margin limits are being potentially crossed, and it will provide a fully holistic picture of the trading activity being undertaken by every trader in the team.

Where positions are growing dangerously large, or where they might indicate that some other, possibly illegal activity is being planned, (insider dealing, market manipulation, etc) the system will send a warning to the compliance team to alert them of the risks being adopted by the trader, and give them an opportunity to act accordingly!

There is absolutely no excuse for any institution not to implement such systems and put them in place immediately. No CEO should be able to say in future that he or she was not aware of the risks of unmonitored trading.

This time, some very senior heads at UBS need to roll. It will not be enough simply to lay all the blame on the trader, there are others who need to share this responsibility.

My private expectation is that this trader has been making some exceptional profits in the past, and that he has been allowed to carry on all the time he was making money. This time it seems he may have read it wrong, or more likely, something in the market has intervened to alter the shape of his playing field. Whatever the explanation, he should never have been allowed to get into this position in the first place.