So the news that $2bn of rogue trades had gone unnoticed will come as something of a shock – both to outsiders, and to UBS’s four-strong risk committee. According to the report, key to the Swiss bank’s risk strategy in the last year has been an investment in new IT systems to monitor risk, focused “particularly in the investment bank”.
Richard Bentley of Progress Software yesterday said pre-trade management is a key area where banks should ramp up their level of supervision, particularly with so much focus from regulators.
“Pre-trade risk management is paramount, with trading limits specified and checked in real-time,” said Bentley.
UBS has also recently hardened its line on risk takers. The new rules mean that those identified as risk takers get extra supervision, 60 per cent of bonuses deferred over three years, and any vesting of equity subject to their financial performance. But while pinning down how one trader managed to sidestep controls will be the immediate focus in the Adoboli case, in the longer-term scrutiny is likely to shift to his stomping ground – the murky world of the exchange-traded fund.
A favourite of regulators, the value of the European ETF market is now estimated at around $325bn, and it remains notoriously opaque.
Richard Reid of the International Centre for Financial Regulation thinks the UBS case will heighten scrutiny of ETFs, but that the risks should not be blown out of proportion.
“It is probably early enough in the growth of these funds to be able to say that they do not represent a truly systemic risk,” said Reid. “Although this will be seen as a real warning signal.”
“We understand that you have already had to contend with unfavourable, volatile markets for some time now...
While the news is distressing, it will not change the fundamental strength of our firm.
- Oswald Grübel to staff”
WHAT IS DELTA ONE TRADING?
Despite being seen by insiders as increasingly important for banks, delta one trading desks only seem to get reported when a trader goes rogue.
So what is delta one? The name refers to an equity flow that tracks an underlying asset. If that security moves by one per cent when the underlying asset moves by one per cent, or as closely to that as possible, then it has a delta of one. Algorithmic systems can be used in order to take profits from arbitrage across fluctuations between the asset and the derivative.
Banks offer delta one services to clients – largely hedge funds – with the bank providing hedging services on these trades. As such, the delta one desk sits between client flows and the bank’s own proprietary trading. As a result some refer to delta one as “flow-prop”. And it is from this position that banks can make big profits.
Every institution has its desk structured differently depending on their focus. But broadly speaking, the banks can profit from efficiency in their role in hedging the delta one trade exposure.
It is estimated that for UBS to have made a loss of this size, it would have had to take a position of at least $10bn.
By Craig Drake