Risk experts: How volatility can expose rogue traders

The revelation of rogue trading at UBS follows a period of market volatility but that is nothing new, say risk managers.

Recent volatility in financial markets may have helped bring the losses allegedly racked up by a rogue trader at UBS to light, risk managers speculate.

The Swiss bank announced yesterday that a trader in its investment bank in London had lost approximately $2bn through unauthorised trading. The employee at the centre of the scandal has been named in the media as Kweku Adoboli, a trader on the bank's delta one desk.

"This often happens when you have periods of high volatility and traders cannot cover their positions," said Carsten Steinhoff, head of operational risk at Norddeutsche Landesbank in Hanover.

"Recent volatility is all the more likely to have brought this case to the surface, given movement in the Swiss franc recently. But I was really shocked by the amount. The case shows us that you cannot predict the amount in any operational loss."

The Swiss franc has experienced huge volatility in recent months, as investors have fled the eurozone in favour of perceived safe havens. The currency has appreciated strongly from 1.219 to the euro on 1 July to an intra-day high of 1.0094 on 8 August.

Worried about the impact of an overvalued currency on its economy, the Swiss National Bank announced on 6 September it would buy unlimited amounts of foreign currency to keep the Swiss franc pegged at 1.20 to the euro.

Meanwhile European equity markets have been extremely choppy over the past few weeks, with investors increasingly worried about a default by Greece and the impact on European banks. The Dow Jones Eurostoxx 50 index fell from 2,559.73 on 1 July, to 2,055.05 at the close on 12 September – a drop of 19.7%.

Similar cases of rogue trading have also tended to come to light after periods of market volatility. In January 2008, Société Générale revealed a rogue trader, Jérôme Kerviel, had cost the bank €4.9bn – an announcement that followed a period of equity market selling. The losses caused by Nick Leeson at Barings also spiralled and were eventually discovered after volatility that followed the Kobe earthquake in Japan in 1995.

A third case saw Bernard Madoff, who ran a wealth management business in New York, sentenced to 150 years in prison for eight federal felonies involving financial fraud, which cost investors $65m.

The wrong-doing was discovered in December 2008, after Madoff was unable to meet redemption payments following the collapse of Lehman Brothers two months earlier.

The most recent revelation of fraud may not be the last – risk managers speculate that the longer volatility persists, the more likely it is that further cases come to light.

"It appears high volatility uncovers fraud, and Madoff is a good example," said Günther Helbock, head of operational risk at UniCredit Group in Austria. "If you are committing internal fraud, you are usually no longer able to cover all traces throughout times of high volatility because you simply cannot act fast enough.

"The unprecedented recent volatility and the downturn in the market have clearly been important. Something like Madoff could well be uncovered now too, given the intensity of the current volatility."

Open access – read Investment Week sister title Risk.net's analysis of Société Générale's famous rogue trading case without logging in:

Risk editorial director Nick Sawyer talks to Jean-Pierre Mustier, former chief executive of SG CIB, about Jerome Kerviel

Nick Sawyer talks exclusively with Christophe Mianné, then head of global equities and derivatives at SG CIB, on the day the Kerviel rogue trading incident came to light

A look at UBS's previous rogue trading incident, from Operational Risk & Regulation