UBS, $2.3b and the blame game

The trial is over and Kweku Adoboli has been sent to gaol. Seven years, is the sentence. The prosecution had compared Adoboli’s crimes with those of a paedophile, rapist and murderer. Crikey, it’s not long ago that he would have been sentenced to 7 years in Tasmania for those crimes, rather than a low security prison for white collar criminals where presumably he will serve out his sentence in England.

The agreed amount of loss has settled on US$2.3bn. This is a big number. A stack of Australian $100 notes piled on top of one another to the total value of A$2.3bn, would be 3.25km high. (One junior relative tried to assure me the equivalent pile in US$ would have to be higher, because the the Aussie is currently more valuable than the greenback. So, I trotted out Dad’s joke #8 on the difference between 1kg of feathers and 1kg of rock.)

Adoboli made the losses during the northern summer of 2011 essentially through loss-making  proprietory trades in the ETF market. As his losses accumulated, he took bigger and bigger exposures. To hide the exposures from UBS risk monitoring, he reported other reverse transactions that reduced the net exposure. But these other transactions were fake. The spiral went on until his arrest on 14 September 2011.

The prosecutor described his trading as “unprotected, unhedged, incautious and reckless.” She called him a liar, a rogue trader and claimed that he knew what he was doing was wrong. The defence argued that the bank and his colleagues knew about the true trading position and that UBS management encouraged additional risk taking.

In fact, both UBS management and Kweku Adoboli are to blame. Adoboli because he deliberately acted outside the rules, he falsified records and tried to conceal his mistakes. UBS management is to blame for inadequate risk management. Nick Leeson blew up Barings Bank nearly 20 years ago. Since then, I know of a further 7 cases, with losses ranging from A$360m to the €4.9b that Jerome Kerviel lost Societe Generale. It is striking how similar the cases are: the rogue trader goes outside the institution’s risk control limits, initially it works and the trader gains confidence, but then losses emerge and bigger exposures are taken to try to recover the mounting losses. Those bigger exposures are concealed by fake trades in the opposite direction and eventually it blows up.

It is hard to find anyone working in a financial institution that does not know about this regrettable cycle and the high profile cases where staggering amounts of money have been lost. Yet institutions with the sophistication of UBS, despite the experience of nearly 20 years, despite fantastic improvements in technology that have made monitoring that much more powerful, despite ramping up regulatory requirements on the management of operational risk, continue to suffer catastrophic losses.

Both parties are to blame in such depressing events. The rogue trader, certainly, for unlawful and deliberately deceitful conduct. But also the employer for turning a blind eye when the trader produces unusual profits and for failing to put its house in order in the first place with effective risk management. There is no excuse for it anymore.