UBS 2011 Rogue Trading Incident Report ABSTRACT What happened to UBS in 2011 was a big financial incident, yet it is a preventable incident. The doings of Kweku Adoboli and other traders there that caused a loss of $2.3 billion could easily be prevented if only the bank had looked at its internal problems. The incident teaches us about the dangers of unregulated incentives, poor security, and exploitative information, and how all these problems can all be fixed to prevent future financial incidents. Table of Contents I. Introduction ..................................................................................................................................... 3 II. What happened? .............................................................................................................................. 3 III. What can we learn? ..................................................................................................................... 4 IV. Conclusion .................................................................................................................................. 5 I. Introduction Derivatives are powerful financial instruments that are worth hundreds of trillions in the market globally, they are so powerful that not only they can make large profits for firms, but they can also take them down. Throughout history there have been many firms that fell victims to bad derivatives trading, and one of them is UBS, this paper will talk about in details what happened to UBS in 2011 and what lessons can we learn from it. II. What happened? On September 14th 2011, UBS chief Oswald Gruebel received information that massive amounts of unauthorized trades have been found within the system, $8.75 billion worth of unauthorized short futures contract still open and is due to settle in a week (Reuters, 2011). A group of traders were tasked to close out these positions to minimize losses, and overnight they managed to close out 2/3 of the positions, unfortunately the remaining losses from the trades rack up to $2.3 billion. Kweku Adoboli was a 31-year-old UBS trader working in the “Delta One” derivatives team, he is the main suspect on the unauthorized trades, shortly after the news has been released, he was captured and taken to court. In Adoboli’s testimony, he explained how he did his unauthorized trades, Adoboli had used fictitious Exchange Traded Funds (ETF) to hedge his futures position, fictitious as in these hedges didn’t exist. Adoboli had found a way to do the trades without raising alarms using his knowledge of the bank’s system back when he worked at the “back office”, with this he was able to do large amounts of unauthorized trades. Adoboli wasn’t the only one responsible, John Hughes was a colleague of Adoboli that helped Adoboli in doing these trades, he later testified that he also did his own trades using the same method. The $2.3 billion losses from the rogue trades created many backlashes, pressures from the government suggesting a ban to proprietary trades and a separation of banks’ investment sector and consumer sector. UBS stock price fell 10% after the news went public, though it’s biggest shareholder, GIC Wealth Fund, did not give up on UBS, and 14 months after the incident, UBS planned to cut 10000 workers (Financial Times, 2011). III. What can we learn? It doesn’t take a detective know why such incident happened at UBS, the incident was simply caused due to a couple of traders who outsmarted the system, ignoring all the potential risk just to get more bonuses. So, what can we learn from this incident? And what we do to prevent it from happening again? For now, let’s talk about the obvious issue, incentives. The traders who caused all this simply did it for the money, these incentives created by the banking culture and the bank itself was what ultimately caused this incident. During his trial, Adoboli stated that the bank was pressuring traders to make more profit promising large bonuses in return, this ultimately created a culture that pressures traders to do anything they can to make profits (Reuters, 2016). When traders are given bonuses based on how much they make on their trades, the goal changes from making safe and profitable trades to making as much as they can from trades, this will eventually lead to reckless behaviour and thus was what ultimately happened at UBS in 2011. The obvious solution to this is for banks to manage incentives, we know from the incident that strong and limitless incentives will eventually cause recklessness, and by limiting these incentives, traders will be dissuaded from doing reckless trades. Incentives are one of many factors that played in the incident, but the incident wouldn’t have happened if the reckless trades were spotted before things go bad. The fake hedges that Adoboli made used forward-settling ETF’s which do not require any confirmations in some banks, which is how Adoboli managed to create fake hedges without the bank’s system knowing (Reuters, 2011). The bank relied on their systems to automatically detect any problems, but like any other systems there is always a way to outsmart it, and when the bank finally realized that their systems are flawed, its already too late. High level institutions like banks shouldn’t rely only on their system for security, therefore banks should implement a multi-layered security and monitor trades carefully, so that in case of a problem if one fails the others can still prevent it. With any systems, there will be a loophole, not only we have to find a way to get rid of any loopholes, but we also must prevent people from exploiting it. The only reason Adoboli knew about the flaw in the bank’s system was because previously he had worked in the bank’s back office, which is where the bank’s administration takes place, Adoboli had used his knowledge of the bank’s administration system to create the so-called fake hedges when he eventually got promoted to work in the front office which is where the bank’s trades take place. Knowledge can be used for good or bad, because Adoboli had worked with the system before, he had the knowledge he needed to exploit the system, information should be controlled so that people who can use the information to exploit the system can’t receive such information. One way to control information is for banks to separate the front and back offices, people who work in the back offices knows more about the system than the people who works at the front offices, and by separating it we are preventing the movement of exploitative information. IV. Conclusion All three factors ultimately boils down on how banks can prevent their traders from doing malicious trades, it’s crazy how a single person can cause a bank to lose $2.3 billion, and the market has little to no blame for the incident, sure the $2.3 billion in losses was due to the market not being on Adoboli’s side after he made the trade, but if the market was on his side back then, he would probably continue to do these trades and the potential losses would only increase. There are no unpreventable factors that contributed to the incident, all factors could be prevented if only the bank had looked, but now it’s already too late, the damage had already been done, and there is no guarantee that these things won’t happen again. REFERENCES American Broadcasting Company. (2011). A rogue trader, a Swiss bank and another financial scandal. Retrieved from https://www.abc.net.au/news/2011-10-05/fullertonubs-scandal/3299546 British Broadcasting Company. (2011). Q&A: 'Rogue trader' allegations. Retrieved from https://www.bbc.com/news/business-14929257 British Broadcasting Company. (2011). UBS 'rogue trader': Loss estimate raised to $2.3bn. Retrieved from https://www.bbc.com/news/business-14965438 British Broadcasting Company. (2011). UBS trader Kweku Adoboli arrested over 'rogue deals'. Retrieved from https://www.bbc.com/news/business-14927432 Marianne M Jennings. (2011). YET ANOTHER ALLEGED ROGUE: THERE IS NO SUCH THING AS A ROGUE TRADER REDUX REDUX. 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