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Adoboli Trading Loss Hastened UBS Investment-Bank Retreat

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Former UBS Trader Kweku Adoboli
Former UBS trader Kweku Adoboli was sentenced by a London judge to seven years in jail on the fraud conviction, and must serve at least half of that term. Photographer: Simon Dawson/Bloomberg

Fourteen months after the largest loss from unauthorized trading in British history, UBS AG is accelerating a retreat from risk taking.

The actions of Kweku Adoboli, the 32-year-old former trader found guilty of fraud in a London court yesterday, hastened a strategic review that culminated in a decision to eliminate 10,000 jobs and dismantle portions of an investment bank UBS spent more than a decade building.

The $2.3 billion loss exposed faults in UBS’s risk controls three years after the Zurich-based bank had to be rescued by the state because of record losses tied to U.S. subprime mortgage securities. Oswald Gruebel, the former bond trader who joined as chief executive officer in 2009, exited after saying he was shocked that one trader could inflict so much damage. Sergio Ermotti, his replacement, deepened and broadened an overhaul at the investment bank Gruebel had begun.

“The trading loss accelerated and maybe gave the necessary internal political impetus to implement the resulting structural changes,” said Florian Esterer, a fund manager at MainFirst Schweiz AG in Zurich. “But they would have happened anyway.”

Adoboli, a native of Ghana who joined the bank in 2003, initially said in an e-mail to a UBS accountant that he had booked fake hedges to hide the risk of his actions. He argued at trial that he was encouraged by superiors to exceed risk limits as he made profits from unauthorized trades. He said nothing he did was dishonest and he intended to make money for the bank.

Seven Years

Adoboli was sentenced by a London judge to seven years in jail on the fraud conviction, and must serve at least half of that term. The jury cleared him on charges of false accounting.

UBS said in a statement it was “glad the criminal proceedings have reached a conclusion.”

Britain’s Financial Services Authority and the Swiss Financial Market Supervisory Authority started formal enforcement actions against UBS over the loss in February. UBS found out in the aftermath of the incident that its internal controls designed to prevent or detect the use of unauthorized and fictitious transactions didn’t work.

“We have been absolutely determined to learn from this incident,” Ermotti said in a memo to employees before Adoboli’s trial started in September. “We have improved internal monitoring and controls to ensure that something like this does not recur, or if it does, to ensure that it is detected and dealt with swiftly.”

Risk Training

UBS introduced mandatory risk training for staff globally and a redesigned training for supervisors, while adding risk management to employees’ performance objectives, according to information on its website.

The bank fell 0.8 percent to 14.38 francs in Swiss trading yesterday. The stock has gained 32 percent since Sept. 14, 2011, the day before the company announced the trading loss, which was initially estimated at about $2 billion. UBS outperformed the 23 percent advance in the Bloomberg Europe Banks and Financial Services Index of 38 companies as the company took measures to scale back the investment bank and concentrate on wealth management.

“UBS must return to what made it strong in the first place,” said Nuno Fernandes, a professor of finance at IMD Business School in Lausanne, Switzerland. “Private banking has always been the core pillar of UBS. And we cannot forget the huge losses during the financial crisis, which were due to its investment bank’s fixed-income business.”

‘Sharpened Minds’

The Adoboli loss sent tremors through the Swiss financial establishment just as UBS was seeking to regain clients’ trust following the subprime debacle and a settlement with U.S. authorities over helping Americans evade taxes. It rekindled a debate about the role of the investment bank at UBS, the world’s second-biggest wealth manager.

“The Kweku case might have further sharpened minds at the Swiss regulator,” said Tom Kirchmaier, a fellow in the financial-markets group at the London School of Economics.

Nine days after the trading loss, then-Chairman Kaspar Villiger, 71, pledged the investment bank would be “less complex, carry less risk and use less capital.” Villiger stepped down in May, a year earlier than planned, to make way for Axel Weber, 55, the former Bundesbank president.

It fell to Chairman Weber and CEO Ermotti, a 52-year-old Swiss native who ran UniCredit SpA’s securities unit before joining UBS in April 2011, to revamp the investment bank.

Profit Target

Under the reorganization announced last month, UBS will cut 10,000 jobs, or about 15 percent of the workforce, over three years. Ermotti intends to boost return on equity, a measure of profitability, to at least 15 percent starting in 2015. The bank previously aimed for between 12 percent and 17 percent.

The investment bank, where job losses may total more than 5,000, will exit most capital-intensive fixed-income businesses and focus on equities, foreign exchange, precious metals and advisory work on mergers and capital-market transactions. Capital demands by Swiss regulators, among the strictest in the world, made it harder for UBS to compete in debt trading.

Andrea Orcel, 49, co-CEO of UBS’s investment bank since July, was named sole head of the unit. Carsten Kengeter, who had run the division since April 2009, took charge of winding down the debt businesses. The revamp will lead to a 100 billion-franc reduction in risk-weighted assets by the end of 2017.

Changed World

“They have been one of the banks that have recognized the world has changed and they need to change with it,” said Paul Lee, director at Hermes Equity Ownership Services in London, which represents institutional investors in Europe, Canada and Australia. “A lot of what they have done should be considered by others.”

Gruebel had other plans when he arrived in 2009. He began rebuilding the securities unit and hiring bankers to make up for firings and departures during the subprime crisis, when the bank piled up more than $50 billion of losses and writedowns. He promoted Kengeter, 45, to co-lead the investment bank with a view toward restoring the fixed-income operations.

In testimony at Adoboli’s trial, Phil Allison, UBS’s head of global cash equities, said there was “a change of ethos” under Gruebel that encouraged more risk taking at the bank, which was averse to risk following the financial crisis. It was an approach Allison said he had generally agreed with.

The expansion by Gruebel, 68, proved poorly timed as the sovereign-debt crisis took hold in Europe in 2010, roiling markets and damping trading profits. UBS started a review to scale down the investment bank last year, and accelerated it after Adoboli’s losses surfaced.

$12 Billion

Ruwan Weerasekera, chief operating officer of securities at UBS’s investment bank, testified on Oct. 9 that Adoboli booked tens of thousands of real and fake trades during the summer of 2011 that exposed UBS to losses that could have reached $12 billion.

“The Adoboli case was certainly not the reason for changing the business model but it was an important event,” said Hans Geiger, professor emeritus of banking at the University of Zurich. “It was an important moment that may have influenced the timing of the” change in UBS’s strategy.

UBS shares may climb 20 percent to 30 percent next year if the bank follows through on the pledge to lower costs and “continues to focus on wealth management, retail and corporate banking and uses the asset management unit and investment bank in a support function,” said Beat Wittmann, head of Dynapartners AG, a Zurich-based asset management company.

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