Rogue Trading and GRC

"When you have supervisors who rely on computer software rather than human contact, there is a false sense of security."
Stephen Brown, Professor of Finance at New York University's Stern School of Business (2011)


"You haven't heard of financial scandals where a rogue trader has earned $2 billion extra for the company"
Barry Staw, Professor of Leadership and Communication at the University of California (2011)


"Compliance monitoring is still regarded in most organizations as a second-class operation."
Stewart Hamilton, Professor of Accounting at Switzerland's IMD (2011)


"The current volatile market circumstances significantly heighten the chances that inappropriate trading practices could quickly lead to record losses, so early discovery and remedial action are even more important than in 'normal' times,"
UK's Financial Services Authority (2008)

Rogue trading risks are related to fraud, undetected errors (eg. typing an extra zero) or hedging strategies outside trader limits. Rogue traders usually deal with high risk investments expecting to create unreported large gains or win large bonuses. However, high risk investment may also create huge losses. A trader is, at the end, a trained professional to place large bets in a competitive environment. For the worse, trading losses can usually accumulate over time.


In the case of the Union Bank of Switzerland, all rogue trading risks were not properly managed for a bank bailed with $ 5 billion from the Swiss taxpayers. According to the explanation from this bank, a junior trader exploited a loophole in contentious synthetic ETFs that caused a $2.3 billion loss on fake over-the-counter positions over the past three years. In Europe, these transactions were not required with a confirmation from banks on the the other side of the trade. The trader allegedly evaded detection by booking fake hedging trades to cover the magnitude of his losses. Because the losses do not affect client accounts, only proprietary trading was done.

Rogue trading is generally prevented by controls including:
a) checking for confirmation from the counterparty or broker by back office,
b) segregating back, middle and front offices (traders should not access to middle and back office systems, order entries and adjustments should be segregated),
c) monitoring the number of cancelled and suspicious trades,
d) requesting continuous holidays for traders,
e) implementing BI controls (real-time transaction monitoring, higher than normal profits, extended settlements),
f) reviewing trading activity by managers (settlement position reconciliations),
g) hiring practices for a strong GRC culture,
h) conservative remuneration structure, and
i) independent internal audits.

Without the conclusions of the investigations at this moment , it is not clear if all these controls could have prevented the USB case. Rogue traders can create complex structures and exploit control loopholes.

In response, some banks diminished the trading units and delta one desks, other banks split off its investment banking business from its core wealth management to shield private clients. Policymakers are also reacting by proposing new regulations intended to limit banks from making high risk transactions.

PS: The last facebook update in the accused rogue trader account was a “Need a miracle".