Fool me once, shame on you; fool me twice, shame on me.
The Swiss Bank UBS is probably feeling more than a little humiliated and shamed today when it had to announce this morning that it had discovered that a trader had caused at least $2 billion in losses to the bank due to unauthorized trading. According to its short press release:
"UBS has discovered a loss due to unauthorized trading by a trader in its Investment Bank. The matter is still being investigated, but UBS's current estimate of the loss on the trades is in the range of USD 2 billion. It is possible that this could lead UBS to report a loss for the third quarter of 2011. No client positions were affected."
Press reports like this one in the London Telegraph say that the trader is 31-year old Kweku Adoboli who was arrested by City of London police.
The announcement stunned the European financial community and no doubt the UK's Financial Services Authority (FSA) and Switzerland's Financial Market Supervisory Authority (FINMA). After the rogue trading by former Société Générale trader Jérôme Kerviel and that by traders at the French savings bank, Groupe Caisse d'Epargne, internal risk management controls were supposed to have been beefed up at all major European banks. In UBS's case, even more so.
The reason is that UBS, which once claimed that it was the world's foremost bank at managing risk, ran up huge losses in 2008 and into 2009 because its risk management systems, practice and culture were so pitifully poor, especially in its trading practice. The bank lost not only its credibility in the market, but also saw several senior executives let go, including its chairmen. In fact, earlier this year, the company hired a new chief risk manager to once gain try to shake up risk management practice at the bank, according to a story in Reuters.
I think the UBS CRO has a bit more work to do, assuming the bank survives this new blow to its reputation and bottom-line.
Latest news reports say that UBS stock had dropped 10% so far today.
I'll be very interested in seeing how this trader managed to get around UBS internal risk controls.
Update: 21 September 2011
Well, after further investigation, UBS has had to up its estimate of its losses to $2.3 billion, according to a statement it released on Sunday. The bank's statement went on to say that it had now covered its risk from the unauthorized trading, and it was now "operating normally" - albeit with much more intense scrutiny of its risk management controls by UK and Swiss regulators.
The UBS press release also gave a bit more detail about what happened:
"The loss resulted from unauthorized speculative trading in various S&P 500, DAX, and EuroStoxx index futures over the last three months. The positions taken were within the normal business flow of a large global equity trading house as part of a properly hedged portfolio. However, the true magnitude of the risk exposure was distorted because the positions had been offset in our systems with fictitious, forward-settling, cash ETF positions, allegedly executed by the trader. These fictitious trades concealed the fact that the index futures trades violated UBS's risk limits."
"Following inquiries directed to him by UBS control functions that were reviewing his positions, the trader revealed his unauthorized activity on September 14, 2011."
The bank has also launched an independent investigation into what happened to understand why its risk controls failed, especially in the wake of Société Générale. The credit rating company Moody's is now looking into whether to downgrade the bank because of perceived "ongoing weaknesses in the group’s risk management and controls that have become evident again."
UBS has also announced, that in wake of the incident, it was going to accelerate the planned restructuring of the investment banking side of its business.
One interesting point that has been brought up by several financial commentators is never expect to hear about rogue traders that create huge profits for a bank: instead they are made managing directors. As one wag put it, if the trader had made $2 billion for UBS, the likelihood that UBS would have unwound the trades, publicly apologized and given the money back was zero.
Robert N. Charette is a Contributing Editor to IEEE Spectrum and an acknowledged international authority on information technology and systems risk management. A self-described “risk ecologist,” he is interested in the intersections of business, political, technological, and societal risks. Charette is an award-winning author of multiple books and numerous articles on the subjects of risk management, project and program management, innovation, and entrepreneurship. A Life Senior Member of the IEEE, Charette was a recipient of the IEEE Computer Society’s Golden Core Award in 2008.