UBS losses were down to the person, not the instrument

Ben Johnson, director of ETF European research at Morningstar takes a look at the facts behind the UBS trading loss.

There has been a fresh flurry of criticism of exchange-traded funds (ETFs) in the wake the news that a "rogue" trader on UBS' "delta one" desk incurred some $2 billion in trading losses. Details are beginning to emerge but many have already pointed the finger at ETFs.

By way of background, delta one trading desks deal in derivative instruments whose objective is to mimic the performance of an underlying asset or benchmark on a 1-to-1 basis. Such instruments include swaps, futures, forwards, and ETFs. Delta one desks most frequently engage in a variety of arbitrage trades aimed at exploiting price discrepancies that arise between these different instruments.

Regardless of the actual instrument involved in this incident, it is not the vehicle that is at fault. Responsibility for this loss lies with the person that incurred it.

This episode also highlights a lack of adequate risk controls at UBS - a fact that is made clear in this piece of reporting from the BBC - and again, not any risks specific to ETFs.

Unfortunately, much of the subsequent coverage in the financial media has missed this point.

ETFs - much as any financial instrument - have many inherent risks. This incident arose out of a risk that is non-specific to any particular financial instrument - investment risk.

A bad trade was made - plain and simple.

All this said, it is important to understand the real risks inherent to the variety of exchange-traded product (ETP) structures. To the extent that this loss impaired UBS' financial standing, the incident underscores the very real and potentially growing (as measured by the widening CDS spread for a number of major synthetic ETF providers' parent banks) counterparty risks inherent to the ETF structure.

The original version of this article can be found on Morningstar.