UBS has announced further details regarding its rogue trading operation. The revelations and their implications are frightening.
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.
I’ve seen some articles saying that UBS has told us how the fraud took place — in fact, it hasn’t done anything of the sort. It has told us what happened, not how it happened. We should be demanding to understand how this was possible.
How can a sophisticated bank’s order management system allow the entry of fictitious trades? In my experience, a proper OMS requires some “hacking” — or an explicit, giant-red-letter debug mode — to get around the checks designed to prevent a trade without a confirmation.
I don’t believe this is as cut and dry as someone entering false trades into a system and walking away — if that’s possible, UBS has much bigger problems than this. This is not just a failure of the front office; this is a failure of the entire risk infrastructure of the bank, of all offices.
I think the telling fact is that the alleged trader, Kweku Adoboli, has something in common with Jerome Kerviel: they were both intimately familiar with the workings of the systems they would later defraud, not as front office users but as middle-office overseers (trade support for Adoboli; compliance for Kerviel).
They knew how to break the machine because they knew how it worked. We talk frequently about the “Chinese wall” between a bank’s investing and trading operations. It’s time to start talking about the one between the front office and everyone else.