Cutting the risk: Banking on technology to stop the rogues
- 27 September 2011
- From the section Business
When news broke that Swiss investment bank UBS had lost $2.3bn (£1.5bn) through alleged rogue trading, the shock was matched by an equally exasperated response of "not again!" as another financial risk management disaster hit the headlines.
After all, not only did the suspected trader, Kweku Adoboli, work in a 'Delta 1' team - the same desk that the biggest ever rogue trader, Jerome Kerviel of Societe Generale, once plied his trade - but the world continues to reel from a global financial crisis which itself stemmed from a monumental failure of risk management amongst financiers.
It leaves a sceptical public scratching its collective head and wondering just what needs to happen for risk to be kept under control in the financial sector.
It might sound surprising but there is no question whether managing risk is a central obligation for financial firms.
"Under UK company law all companies are required to have a duty of care towards shareholders assets and that includes risk management," explains Prof Brian Scott-Quinn from Henley Business School.
"Under FSA rules they have additional responsibilities, they have to take reasonable care to ensure that any activities in control functions [essentially roles with 'significant influence'] are properly controlled," he adds.
But it is no mean feat to do this; across August an average of 880,000 trades were completed each day on the London Stock Exchange alone, with an average daily value of £6.17bn.
Financial firms have back-office functions that are there to confirm transactions are above board, but such is the volume that the only way they can keep up is with increasingly advanced technology.
Technology kicks in
Mat Newman is vice-president at SunGard; its software processes millions of transactions for its financial sector clients every day.
"The interconnectedness of what banks are trying to do across different geographies, different time zones and different trading desks, and asset classes is just immense these days," he says.
"One of the key things banks are faced with as a challenge is how to bring this together, this vast amount of data and make sense of it at the same time - so they can see the wood for the trees."
Without such technology companies don't have a hope of gathering the information they need, analysing it and presenting it to the right people at the right time.
"These days you have systems that will monitor your current positions against those risks and you have a whole series of bells and whistles that will flag not just if you breach those limits but if you come close to those limits," says Mark Hanney, CEO of Valbury Capital stockbrokers.
This is crucial for Valbury Capital, which takes trades from clients and then passes them on to the markets, theoretically running a no-risk business model.
"If a client is trading with us they put up a certain amount of margin, and if that margin is insufficient for their positions then our systems can automatically stop them out," Mr Hanney explains.
"Those systems can apply internally as well, so if a trader goes beyond a certain position then those systems are able, once they've breached those limits, to automatically close the position out."
The "bells and whistles" that flag up problems come in all shapes and sizes, dependent on the technology a firm opts for.
"Exceptions can be flagged graphically on summary dashboards with a number of graphical metaphors employed in the form of traffic lights, dials and graphs," says Daren Cox, CEO of Project Brokers, which supplies data analysis tools to investment banks.
He says that graphics rather than tables of data are often favoured simply because they mean that potential problems are easier to spot.
There are certain key areas of risk on which the technology is often brought to bear.
These include liquidity risk (how much cash you have and whether you can meet your obligations), market risk (what's going on out there in the markets) and one of the biggest of all, credit risk - basically how much people owe you and whether they are going to be able to pay it back.
Abusing the system
With the key flash points picked out and technology that can make a decision on whether a deal is a good idea in less than 10 milliseconds, the obvious question is why things seem to go wrong so regularly?
"One of the main problems these days - as it was in 2008 - is not the system but its operators," says Michel van Leeuwen, CEO of financial compliance consultancy, IMS.
"Their intelligence, experience, vigilance, their clout in the hierarchy and the simple analogy of 'having a clock' is irrelevant if you never look at it or don't look at it frequently."
Technology is also open to manipulation if you know how.
"Part of the problem is the rogue traders we have seen in the past have come from a back office function and they know these processes very well," says Mat Newman of SunGard.
"What's quite common in the City is to grow your own talent from the back office and bring it through to the front office."
Mr van Leeuwen calls this "akin to inviting the cat into the pigeon coop".
"It would be wise not to hire a trader that used to be a... back office employee," he says.
"The imperative, regulator imposed, 'Chinese wall' imposed in process and procedures, doesn't seem to have made it to the frontal lobe of HR or the heads of trading."
There is a temptation with financial crisis in the air and an angry public after blood to overemphasise the down side of the risks financial institutions take.
But John Macdonald, executive vice-president at financial software firm Algorithmics, says risk management technology should not just be a way to stamp down on transgressors.
"Any one transaction can be analysed by one individual but it may take some time - if you have a customer you provide banking services to they don't want to wait two or three days for a decision," he says.
"Businesses need to be able to have access to funding and making the right decisions helps the economy grow.
"That's all part of risk management - being able to measure and then decide what level of risk you decide to take because you make a return on the capital you use by taking risk."
Of course there will be those that argue that on occasion slowing everything down a bit and taking a day or two rather than a thousandth of a second to mull a deal over might be a good thing.