The proceedings launched by the Swiss Financial Market Supervisory Authority FINMA into UBS's trading losses in London have highlighted serious deficiencies in risk management and controls at UBS's Investment Bank. In FINMA's view, the fraudulent transactions executed by the rogue trader would have been detected sooner if these deficiencies had not existed. As soon as the unauthorised trading activities became known, FINMA imposed preventive measures to limit UBS's operational risks. Now that its proceedings have been completed, FINMA is appointing an independent third party to ensure that corrective measures are successfully implemented.
In September 2011, FINMA together with the UK regulator, the FSA, launched a comprehensive independent investigation into the events at UBS (press release
). Its aim was to clarify the circumstances that led to serious unauthorised trading losses at UBS's London office and review the control mechanisms at UBS's Investment Bank. In December 2011, FINMA initiated formal enforcement proceedings (press release
Today, FINMA is publishing a summary report detailing the conclusions of the proceedings and disclosing the measures it has taken as well as those implemented as a first step immediately after the trading losses became known. The far-reaching immediate measures ordered by FINMA include capital restrictions and an acquisition ban on the Investment Bank. Moreover, any important, new business initiative which the Investment Bank intends taking must initially be approved by FINMA. In order to monitor the progress of the measures imposed, FINMA is appointing an independent investigator and, at a later stage, will engage an audit firm to review whether the steps taken by UBS have proved effective. FINMA is also further examining whether UBS must increase capital backing for its operational risks.
Background to the trading losses
In mid-September 2011, UBS discovered that trader X, who was employed on the Exchange-Traded Fund (ETF) desk of its Investment Bank in London, had been engaging in unauthorised trading. The ETF desk traded in a variety of financial instruments designed to meet the investment needs of UBS clients. The desk also traded on its own account. As a director-level employee, trader X executed transactions for the bank's account in excess of his defined limits and concealed the risk exposures. By using a range of prohibited mechanisms, he succeeded for a substantial period in covering up the actual scale of his trading positions and the risk they posed. The mechanisms used included one-sided internal futures positions, the delayed booking of transactions and fictitious deals with deferred settlement dates. UBS suffered losses of USD 2.3 billion. Trader X also created a mechanism, which he referred to as the "umbrella", for smoothing out profits and losses. On 20 November 2012 trader X was found guilty on charges of fraud by abuse of position and not guilty on charges of false accounting at the end of his trial in London.
Unclear monitoring responsibilities
Responsibility for monitoring and controlling the ETF desk was split between the line managers in the front office and three separate control functions. The Operations unit was responsible, among other things, for ensuring that the ETF desk's trades were correctly recorded and processed. Product Control, part of the Finance department, was responsible for ensuring correct reporting and plausibility checking of profits and losses, while Risk Control was tasked with monitoring and evaluating the risks from trading activities.
Line managers were uncertain of what their functions and responsibilities were as regards monitoring the ETF desk. One aggravating factor was that, following a reorganisation in April 2011, the direct line manager was located in New York. No specific arrangements were made for transferring responsibility for monitoring. Warnings did not get as far as the new direct line manager in New York and ended up instead with the previous line manager in London. He received and acknowledged them, even though this was no longer his responsibility.
Between June and July 2011, it became clear on at least four occasions that trader X had exceeded his limits. In one of these cases, he revealed to his manager in New York that he had made a profit of USD 6 million by taking a position of more than USD 200 million, far in excess of his approved risk limit. The line manager first congratulated trader X on the profit and only later reminded him that he needed permission to exceed his limit. The inadequacy of the controls was also made clear by an incident in August 2011 in which fictitious ETF trades with deferred settlement dates generated irregularities amounting to half a billion dollars. These warning signals were accepted without further investigation.
Control functions too weak
The three control functions also failed to properly investigate the many warnings triggered by transactions from the ETF desk. For example, the unusually large profits generated by the ETF desk starting in the first quarter of 2011 were not critically examined.
It was common knowledge in the London trading room that the ETF desk caused many reconciliation errors, often as a result of late or incorrectly booked transactions. These concerns were discussed neither with the Product Control unit nor with senior management. Starting in June 2011, the reconciliation errors became substantial, with the unexplained amounts sometimes exceeding USD 1 billion.
Operations saw its role as providing services to trader X and raised no serious questions about his activities. Although reconciliation errors remained unresolved over several weeks, explanations provided were implausible, and inconsistencies were occasionally escalated, trader X's managers and controllers were too quick to accept his explanations. Even at a meeting held on 24 August 2011, managers came to the conclusion that no large amounts of money were at risk.
In August 2011, trader X once again persuaded Product Control that losses of one billion dollars shown in the trading systems were incorrect. His assurance that he would correct these "booking errors" in the near future was accepted without objection. In fact, trader X's aim was to remove the bank's losses, at least temporarily, from the books. In addition, an important control report was not produced at all for a period of several months without anyone noticing this fact.
FINMA's main findings
On the basis of these findings, FINMA has reached the following conclusions:
- The direct line managers failed to properly monitor the ETF desk in London. Trader X's relationship with his line manager and the internal control functions was based too much on trust and too little on control.
- The front office monitoring instruments deployed by the line manager responsible for the ETF desk had major shortcomings and were not used properly.
- The control functions had too little understanding of the trading activities in question and were therefore unable to challenge the ETF desk's actions.
- UBS's various control functions did not collate their information to produce an overall picture.
- Operational risks were evaluated to a large extent on the basis of a self-assessment process, which was carried out just once a year by traders and internal controllers. Improvements to this process had been in train since January 2011, but were completed too late.
- Reporting channels and responsibilities were unclear and led to confusion.
- The relocation of direct supervision of the ETF desk from London to New York was badly managed and led to a situation in which the London desk was not adequately monitored from April 2011 onwards.
- UBS sent out misleading signals by awarding pay increases and bonuses to a trader who had clearly and repeatedly breached compliance rules, and by accepting him onto a junior management programme.
Immediate measures implemented by FINMA
As soon as the trading losses were discovered, FINMA imposed until further notice a range of preventive measures on UBS:
- Any new business initiatives which UBS intends to take in its investment bank and which are likely to lead to increased operational complexity require prior approval from FINMA.
- The risk-weighted assets of UBS's Investment Bank are subject to an upper limit which reduces gradually over the period 2012 to 2015.
- The risk-weighted assets of the London branch are also subject to an upper limit which reduces over time.
- UBS's Investment Bank is prohibited from making new acquisitions.
UBS's corrective measures
Since the trading losses, UBS has introduced a large number of organisational measures to strengthen its risk management and control capabilities. Action has been taken on the personnel front, core processes in the front and back offices have been modified, and deficiencies in the processing of trades have been addressed. These, along with other measures, are currently being implemented.
Further measures taken by FINMA
In a newsletter to market participants published on 13 December 2011 (FINMA Newsletter
), FINMA specified its expectations regarding controls to prevent unauthorised trading. As part of its supervisory remit, FINMA is checking the extent to which the most important supervised institutions meet these expectations.
FINMA is closely supervising the implementation of the corrective measures at UBS and has now decided on the following additional actions:
- FINMA is appointing an independent investigator to control the implementation and completion of the corrective measures at UBS.
- Once the project is completed, FINMA will engage an audit firm to review whether the measures implemented by UBS have proved effective.
- FINMA is further examining whether UBS must increase capital backing for its operational risks.
The ruling dated 21 November 2012 and the report published today mark the end of the formal enforcement proceedings initiated by FINMA against UBS on 16 December 2011. In coordination with FINMA, the Financial Services Authority (FSA) in the UK is also closing its enforcement proceedings and is imposing a fine of GBP 29.7 million on UBS.
Tobias Lux, Spokesperson, Tel. +41 (0)31 327 91 71, email@example.com