Saturday, September 17, 2011

Another Rogue trader damages his bank.

Swiss Bank UBS has lost an estimated $2 billion because one of their traders in London, Kweku Adoboli, "went rogue." Julia Felsenthal at Slate Magazine explains what a rogue trader is. But first, who is Kweku Adoboli?

Kweku Adoboli is a 31 year-old british trader for the Swiss bank UBS. He was born in Ghana 15 Sept. 1980 and attended Ackworth School, a highly regarded Quaker school located in the village of High Ackworth near Pontefract, West Yorkshire, England. After that he was accepted to the extremely competitive University of Nottingham where he studied computer science and management. He graduated from there in 2003. From his educational history is it clear that Adoboli is a very capable individual.

According to the Wall Street Journal:
Adoboli started at UBS in London as a trainee in March 2006, according to the Telegraph newspaper. On the LinkedIn profile, his title is listed as “Director ETF and Delta1 Trading at UBS Investment Bank.”

Investment banks’ Delta One operations trade securities that attempt to track an asset closely. Our Journal colleague Paul Sonne reported Adoboli has worked since 2006 in the European equities division of UBS, focusing on exchange-trading funds, or baskets of securities that aim to track a specific stock index or commodities.
The Slate Article describes how traders are supposed to deal with risk.
Every trader is allowed to take on a certain amount of risk, and if he wants to exceed that value he must get the permission of his supervisors. ("Risk" refers not to the amount of money invested but rather the amount one might expect to lose on a particular gamble given the best available estimate of the odds.) Traders are said to have gone rogue when they've either made investments that are too risky, or invested much more money than they're supposed to.
What did Adoboli do that went so wrong? It looks like he made some losing trades, then attempted to take riskier trades or larger trades that would cover his losses if he succeeded, but they also failed. Somehow UBS risk management system failed to identify the risks and their size, either because Adoboli concealed them or because the risk management system was inadequate. Here's more from Slate.
A starting employee at a bank like UBS might be allowed to take on risk measuring in the thousands, not millions, of dollars. As a trader gains experience—and demonstrates an ability to make a profit—his authorized risk would increase; a very senior person at a bank might even be permitted a billion dollars' worth of exposure. Nobody has reported just how much Adoboli had been trusted with, but the Wall Street Journal did report that he worked for an equities desk called Delta One that conducted relatively safe trades. Charges against Adoboli allege that he falsified accounting records going back to October 2008. That suggests he was hiding unauthorized losing investments for a long time, as opposed to making one gigantic, really bad bet.
It has been reported that UBS' internal controls did not recognize that Adoboli was conducting unauthorized trades. He handed himself into UBS and told them what he had done, and only then did they realize that UBS had lost approximately $2 billion on his trades.

Two earlier rogue traders were Nick Leeson and Jérôme Kerviel. These were traders who were conducting large numbers of trades, made losing trades and learned how to conceal those losing trades from their supervisors while they took increasing risks attempting to achieve an overall winning situation. Nick Leeson's trades bankrupted and destroyed the Barings Bank. Jérôme Kerviel was similar to Adoboli in that Kerveil was a junior trader in the Delta One financial products department of the French bank, Société Générale. Kerviel lost approximately €4.9 billion for the bank through his trading actions.

Kerviel has always claimed that his supervisors were aware of his trades and that he simply became the fall guy when the trades failed. Did the risk management systems really fail in all three of these cases? How much did managers really know about the trades before they were exposed?

The massive power of these big banks to damage the lives and livelihoods of billions of people has be been clear since they initiated the Great Depression, and again has been exposed by their disastrous actions which caused the mortgage fraud that led to the financial collapse of Wall Street in 2008. The unrestrained management of these massive institutions cannot be trusted. This is the message that the Wall Street protesters are highlighting this weekend.

This story begins with one more banking "rogue trader", but it highlights the real problem of rogue financial institutions themselves.

Addendum 9/20/11 @ 1:43 AM CDT
Here is One view on why Bank Reform has not stopped rogue traders.

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