Thursday, 22 September 2011

Why Do Rogues Trade?

As the sorry tale of Kweku Adoboli's rogue trading unravels it poses some fundamental questions which originally started for me when Nick Leeson broke Barings Bank all those years ago.

I suppose it's a bit like Ponzi Schemes - you will always get caught out in the end but while everyone remains oblivious you make seemingly huge profits which you spirit off somewhere. But in rogue trading it should be different. 

Adoboli was making trades betting on the future direction of stock indices - this is not essentially a crazy thing to do. After all, many pension schemes and funds do much similar things. However, under normal circumstances, if a trader was making excessive bets on such things, building up a precarious position, then surely he would be spotted.

Like Leeson in the old days, Adoboli hid his tracks by creating fictional trades offsetting his bets with what are known as Traded Exchange Funds. He kept doing this for a period of months. To UBS, it appeared that all bets were covered - allegedly.

All this makes you feel sorry for the bank, doesn't it? I mean it must be a wonderful world where you believe that all daft bets get coincidentally covered by good ones and vice versa but such is the nature of banking. It's a game and we just allow it to happen with astronomical amounts of money. Daily.

So back to our rogue trader. Had his bets come good then his winnings would have been offset by losses from his cover positions. So he would not have made a great deal in incremental bonus - would he? As it happened, his bets lost and they ended up not being covered by his cover bets as they were fictional.

OK, so how did Adoboli plan to make money if his winning bets would have been offset by corresponding losses?

To understand this, you need to understand bank reconciliations systems and bonus schemes. I don't know what these are but it is pretty clear that rogue trading would not occur if bank bonus schemes were not always linked to the reconciliation system - or at least the two may not be synchronised. I.e. there must be a gap between booked wins and actual losses.

In that gap, it is the only time where the rogue trader can book a win, get paid and scarper.

Once again, it brings into sharp focus the culture of laissez faire systems, lack of accountability and bonuses. In reality, the ten year period up to 2007 was just a gigantic bonanza of rogue trading as the products 'making money' were not actually doing so. When the whole thing went into meltdown, bonus pools of the proportions of sizeable country economies had been paid out to a small percentage of the world's population who then collectively waved two fingers at us, took our bail outs and started it all again with zero impunity. And the system hasn't changed - hardly enough to stop this money making culture which delivers long term threat.

I dare say that in the world of banking Adoboli is seen as the unlucky one whose little scheme didn't win. If bonuses are paid out in such ways then I dare that such rogue trading is probably far more rife than we would imagine. It's just that more people place winning bets than losing ones. 

If that's the case - boy are we all in for a fall some day.

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