UBS Trading Scandal - Right Verdict; Wrong Man

By August 2011, the bank's risk exposure had ratcheted up to almost $12bn - enough to bankrupt it - but its back office was still blissfully unaware of its full magnitude. How can a fraud on such a scale go undetected for three years?

The blame for Britain's biggest ever banking fraud has been pinned squarely on the shoulders of a one man. Meanwhile UBS, the Swiss bank that uncovered trading losses of US$2.3bn and veered close to bankruptcy as a result, has been painted the victim. But whilst Kweku Adoboli, the Ghana-born trader who perpetrated the fraud, undoubtedly deserves to go to jail, the real question is how such a crime could happen at one of the world's leading investment banks and why no one higher up the chain of command is facing criminal charges.

Adoboli's scam started in 2008. He exceeded his $100m daily trading limits and invented fictitious trades to hide his losses. Remarkably, UBS claims that it only discovered the true extent of the risk exposure they faced from his unauthorised trading activities in the summer of 2011. By August 2011, the bank's risk exposure had ratcheted up to almost $12bn - enough to bankrupt it - but its back office was still blissfully unaware of its full magnitude. How can a fraud on such a scale go undetected for three years? And if it did, why has UBS's trading licence not been revoked by the Financial Services Authority on the grounds that is its managers are not fit and proper to supervise trading activities of this kind?

Five years ago, Societe Generale revealed a similar trading fraud, disclosing losses of €4.9bn. The French bank too blamed these losses on a single rogue trader, Jerome Kerviel. In their defence statements at their respective trials, both Kerviel and Adoboli alleged that senior management knew what was going on at their trading desks. Both men also claimed that their bosses actively encouraged risk taking and sanctioned rule breaches when they judged them to be profitable, only to make scapegoats out of these junior traders when the losses spiralled out of control. Both banks vehemently deny that.

Banks are custodians of our money. We expect them to have watertight controls. If several staff collude to evade a bank's internal controls, frauds are always possible. But those controls should be sufficiently robust - and involve sufficient segregation of duties - that a single person acting in isolation could never be in a position to perpetrate a fraud on this scale.

Most bankers will tell you the controls in place are fine. The problem is the culture prevalent at leading investment banks. This bonus-driven culture raises a number of concerns: how effectively are these controls executed; which departments wield the greatest influence within the bank; when are controls overruled and by whom; are shareholders' - and deposit holders' interests - foremost in the minds of senior management.

Banks, like all commercial businesses, have to balance making money on the one hand with managing risk on the other. But the bonus culture that has gripped the global investment banking sector over the last two decades has skewed that balance. Moral hazard (which refers to the concept that bankers will continue to take excessive risk as long as they know that the government will always be there to bail them out) creates further imbalances. And the conflicts of interest that are associated with investment banks' activities - many banks have been fined for putting their own interests ahead of their clients' interests - sways the balance even further away from sound risk management towards profit maximisation.

Front office staff - the traders - are charged with making money, whilst back office staff - the risk managers, operations managers and compliance managers - are tasked with monitoring risk. Tensions between the front office and back office can be high. Power struggles are commonplace.

It is inconceivable that mangers higher up the chain of command were unaware of the levels of risk taken on by traders like UBS' Adoboli or Societe Generale's Kerviel. Today's high-tech trading floors have real-time monitoring systems. Typically, within a matter of hours, staff in the operations department would be aware of the trades and any material discrepancies. Within 24 hours staff in risk would be alerted to exposure levels, informing them whether risk limits were breached or that something else was wrong. From that point three scenarios could have come into play. The risk managers could have been too intimidated by the bank's "star traders" to report their findings upwards; they could have been satisfied with the explanations given by the trading desk for the irregularities and made a judgement to close the matter; or they could have reported it upwards only to be overruled by senior management.

One reason that senior managers may have overruled them was because they believed the risk exposure levels to be acceptable. Their decision may have been influenced by the impact those trading positions were likely to have on their year-end bonuses. At the heart of this decision point lies the skewed relationship between the trading function and the risk management function at many investment banks. Until the 2008 financial crisis, risk managers at bulge bracket banks often had very little credibility at board level when confronted by a "star trader", so many of these power struggles were won by the trading desk. This is partly due to the way banks are organised. In recent times the senior echelons of bank executives have been dominated by front office staff - the rainmakers. As a result, risk management has been grossly under-represented at board level.

Despite the fact that no UBS member of staff has come out in Adoboli's defence, it is highly unlikely that Britain's largest ever banking fraud was the work of one man acting alone. So it is worrying that prosecutors chose to go after a relatively junior rogue trader rather than prosecuting someone higher up the chain of command.

For many years, banks have been playing a complex game of chess with the authorities. Time after time, they have outmanoeuvred law makers, central bankers and regulators. It is a shame that the authorities have, once again, decided to respond to a fraud of this magnitude by killing a pawn instead of taking out a few knights.

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