UBS’s $2 Billion Loss May Spur Regulators’ Push to Curb Bank Trading Risks

Less than two months after UBS AG (UBSN) Chief Executive Officer Oswald Gruebel said the bank had “one of the best” risk-management units in the industry, his firm posted a $2 billion loss from alleged “unauthorized trading.”

The disclosure exposed flaws in the bank’s risk controls that may prompt regulators to restrain lenders from making bets with their own capital, academics and analysts said. Britain’s Financial Services Authority and its Swiss counterpart yesterday said they would also investigate the UBS trading losses.

“Clearly, UBS’s risk-management systems aren’t fit for the purpose, or this couldn’t have happened,” said Giorgio Questa, a finance professor at Cass Business School in London and a former banker. “It shouldn’t be possible to build up losses this big. Regulators are likely to force them to get out of this field of trading.”

The Swiss lender said yesterday that the loss at its investment bank was caused by a trader it didn’t identify. Police in London today charged Kweku Adoboli, a 31-year-old UBS employee, on suspicion of fraud by abuse of position. He worked on the Delta One desk, a team that handles trades for clients and took risks with the bank’s own money in arranging trades.

The regulators’ investigation, to be carried out by a third party, will focus on “the control failures which permitted the activity to remain undetected” and “will include an assessment of the overall strength of UBS’s controls to prevent authorized or fraudulent trading activity in its investment bank,” the FSA said in an e-mailed statement today.

‘Needs to Be Done’

“When we see what’s happened in the last couple of days, it’s obvious that there is still more that needs to be done to ensure we reach appropriate regulation and supervision,” Michel Barnier, the EU’s financial services chief, said in a Bloomberg Television interview in Wroclaw, Poland, after a meeting of euro-area finance ministers yesterday.

Global regulators are pressing banks to curb proprietary trading. The loss may revive calls for firms to increase controls on risk and separate their investment banking from retail businesses.

A government commission led by former Bank of England Chief Economist John Vickers this week recommended banks erect firewalls between consumer and investment-banking units to safeguard customers and the taxpayer.

“Whether it’s because of an irresponsible trader or failure in the prevention of risk taking, I’m convinced you can’t stop some investment banks taking on more risk than others,” said Martina Metzger, executive director of the Berlin Institute of Financial Market Research. “What you can do is separate investment banking from depositors’ money.”

‘Rogue Trading Risk’

No matter how robust a bank’s controls, if someone is determined and knowledgeable enough they are likely to be able to circumvent those systems, according to David Berman, partner and head of financial-services regulation at London-based law firm Macfarlanes LLP.

“Whilst it is questionable whether rogue trading risk can ever be entirely eliminated, firms will at the very least be expected to ensure that the chances of it happening internally are minimized,” Berman said. “Regulators will likely expect institutions to revisit and reassess their own systems and controls.”

UBS’s loss is the largest of its type since former Societe Generale derivatives trader Jerome Kerviel caused a 4.9 billion- euro ($6.8 billion) loss in 2008.

Britain’s FSA has said it had discussed the Kerviel case with as many 50 banks in London and that “many had already put in place reviews to ensure they identify any gaps in trading controls and close them as soon as possible,” according to a policy document from March 2008.

Value at Risk

Banks monitor traders’ risk-taking through daily calculations of value-at-risk, which mustn’t exceed specific thresholds, as well as measures of counterparty risk, according to Marco Delzio, founder of Martingale Risk, an advisory firm.

When valuing structured derivatives, banks rely on prices and measures, such as correlation, that aren’t available on the open markets, said Delzio. It’s possible for a trader to hide losses by entering false prices that can’t be verified, he said.

This isn’t the first time that UBS has been caught out by “unauthorized” trading.

Two years ago, the FSA fined the Swiss bank 8 million pounds ($12.7 million), at the time the third-largest penalty ever imposed by the regulator, for not stopping employees in its U.K. international wealth-management business from making unauthorized trades with customer money in 2007.

Remedial Steps

The bank said at the time it “deeply” regretted the incident and had taken “full remedial steps.” A spokesman for the bank in London yesterday declined to comment on internal risk controls.

Gruebel, who previously ran rival Credit Suisse Group AG, came out of retirement in February 2009 to run UBS. Since joining, he has sought to install tighter controls at the investment bank. He started weekly calls with top risk officers and was personally monitoring traders’ positions, together with Carsten Kengeter, who runs the investment bank.

“I’m pretty convinced that we have one of the best risk management in the industry,” Gruebel said on a July 26 call with analysts as the bank reported second-quarter earnings.

To contact the reporters on this story: Gavin Finch in London at gfinch@bloomberg.net; Ben Moshinsky in London at bmoshinsky@bloomberg.net; Elisa Martinuzzi in Milan at emartinuzzi@bloomberg.net.

To contact the editors responsible for this story: Frank Connelly at fconnelly@bloomberg.net; Anthony Aarons at aaarons@bloomberg.net.

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UBS CEO Oswals Gruebel

Peter Frommenwiler/Bloomberg

UBS Chief Executive Officer Oswald Gruebel.

UBS Chief Executive Officer Oswald Gruebel. Photographer: Peter Frommenwiler/Bloomberg

Enlarge image

UBS CEO Oswals Gruebel

Peter Frommenwiler/Bloomberg

UBS Chief Executive Officer Oswald Gruebel.

UBS Chief Executive Officer Oswald Gruebel. Photographer: Peter Frommenwiler/Bloomberg