How to lose $2 billion: Swiss holes in an investment culture
With reputations under attack again following revelations that a rogue trader had lost UBS $2bn, there will be increased calls for the splitting of banks’ functions. However, once again, behaviour appears to be at the root of the loss.
Coming as it did after the Vickers Report which recommended the ring-fencing of retail banks from the investment side, the Kweku Adoboli story was a fillip for critics such as Coalition business secretary Vince Cable.
However, this is not a reason for taking an even harder line with banks and there is a risk that the bigger picture – what is good for the UK? – will be lost in the catcalls that will no doubt get louder after these events.
As I have pointed out previously, a lot of what has happened in finance over the past few years, or indeed forever, has been behavioural. Judgment calls have been wrong, or banks have been too eager to lend or politicians have been too eager to tax without working out what the effects will be.
And it appears that there is a behaviour issue here coupled with poor corporate governance.
Most traders nowadays are surrounded by risk and compliance managers. They are checked at least once an hour; some are checked every twenty minutes, to keep an eye on what their positions are. In addition, traders are given ceilings with which to trade, a ceiling that will allow for an “acceptable” loss during a day’s trading.
Yet this appears to have gone wrong for UBS. Where were their risk managers? Where was compliance? How did Adoboli manage to rack up $2bn in losses?
UBS had a reputation for stolid, conservative banking before it has to be bailed out by the Swiss authorities in 2008. In total, the bank lost around $50bn in the financial crisis and the chief executive Oswald Gruebel has worked hard in restoring its reputation.
However, it may be that its conservatism was the issue.
Unlike their “Anglo-Saxon” counterparts in the US and UK, the Swiss – and for that matter the German – banks were not known as having risk cultures. Steady and sure.
So when they got into the investment market boom after deregulation, could it be that they were ambushed by the risk culture? Did their behaviour cause them to not recognise where the risk issues were?
Or maybe, they were swept up in the investment frenzy that was going on? Certainly, judging by their debt exposures, they took on positions which most UK banks would baulk at without better hedging.
So how could $2bn disappear without being noticed? Well, the good money’s on this being in the so-called exotic markets of options and derivatives and was probably traded through an exchange-traded fund. These are not highly regulated and in the vast majority are not regulated at all as most are considered as private rather than public deals, coming as they do between two parties.
The likelihood is that Adoboli has positions based on the Swiss franc. As with all investment risk, the timings have to be right. If my suspicions are right, his timings weren’t. The Swiss Central Bank devalued the franc at an astonishing rate last week to prevent a damaging high run as people fled to it for safety amid euro and dollar fears.
If this is the case, Adoboli probably positioned himself for the high price without a decent hedge put in place.
Even so, the fact that UBS allowed $2bn to be placed, probably in a series of trades, shows a disregard, or perhaps even an ignorance, of risk. Indeed, this morning there are reports that it was Adoboli who informed the bank of his losses. This appears to be a fundamental flaw in its internal control systems and seems to show that UBS has some serious governance issues.
How do you regulate against behaviour? You can’t. You can inform, educate and train but as has been seen with the outgoing Financial Services Authority, tick-boxing is no guarantee against behavioural risk, or fraudulent actions.
What is coming though is a greater transparency for these trades in the light of global regulatory changes. Will it stop rogue trading? No. One determined individual will always be able to go rogue. What this may do is help banks keep track of “off-market” trading and allow risk managers to do their jobs with good information.
Finally, there is one thing I wish to point out. Speaking on BBC News 24 on Thursday night, I gave a brief summation of the probable trade Adoboli used to get these losses. This in turn was described by the presenter as “a bet”. Well, yes, yes it is.
But all investment by its nature is a bet. Unless you have inside information, you have to use your judgement to work out what the probable outcome for the company, share or currency is down the line. This is no different from using the form guide when you pop down to Ladbrokes to bet on a football team or horse.
Investment is a risk, there are always winners and losers, and it is the nature – not the fault – of the system. After all, if UBS is a $2bn loser, somewhere there is a $2bn winner.
Simon Miller is the Editor of Financial Risks Today
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