Getting to grips with Rogue Traders

At a City forum yesterday a representative from the FSA presented the seventeen definitions behind the operational risk management principles, which financial services firms are expected to practice to prevent rogue trading and other fraudulent activities.

I could not help noticing that the word ‘limit’ was used frugally. It was in fact only used only once within the definitions. Surely this is an extreme limitation of a key word in an area where you would expect limit management and responsibility to be absolutely crucial.

Pre ‘Big Bang’ the financial institutions I worked in had very distinct and robust limit management controls. These controls were set and reviewed monthly by the risk committee and if the firm was entering a new product or market, the risk committee would undertake an assessment, which was then presented to the board for approval before any dealing commenced.

The risk limit structure was by trader/salesman, then by financial product/investor account and then market. This was both from a domestic and international aspect. The individual limit was set and managed by the desk limit, which in turn was managed by the department, then the risk committee and then the board.

Limit breaks were managed in real-time from the desk and reports of limit breaks reported at the days end, up through the various responsibilities I have just described. If there was a serious break the problem would be quickly escalated up through the chain of command.

Responsibilities were clearly set and if they were regularly broken reprimands given, or suspension or job loss in the most serious cases. Everyone knew their roles and responsibilities and limit breaks were kept to the minimum. Rogue traders were not part of the City vocabulary until Nick Leeson.

Why then with this proven risk management structure working well in the past, do regulators and FIs find it so difficult to manage today? Don’t give me arguments about complexity or volume, as today we enjoy some of the best technology ever devised to assist, which was not available back then. I suspect the real reason why we see it prevailing today is down to people.

It’s the culture within FIs, the capability of people to understand their responsibilities and the ability to do their job and the fear of becoming a whistle blower, which causes many of the problems.

Managing limits is easy, providing there is stringent and robust management and a structure that enables transparency of problems so early resolutions can be introduced. And of course the penalties for failure must be severe and acted upon.