THE $US2 billion ($A1.95 billion) trading loss that has rocked Swiss bank UBS has also cast a spotlight on a relatively unknown but increasingly profitable corner of Wall Street Delta One desks.
Both Kweku Adoboli, the UBS trader in London arrested on Thursday over the loss, and Jerome Kerviel, the Societe Generale trader who was responsible for $US6.8 billion in losses in 2008, worked on such desks.
While Delta One may conjure up images of Top Gun fighter pilots, the desks get their name from the financial definition of "delta", which refers to the change in a price of a derivative against the change in the price of a customised underlying asset, like a basket of stocks.
Most Wall Street firms have such desks for their clients. Buying a derivative that closely tracks an underlying asset can be easier or less risky than buying the asset itself. Instead of buying bars of gold, a hedge fund manager may buy an exchange-traded commodities fund, or even a gold fund. These derivatives can also be attractive because they typically require little upfront capital.
In some cases, the Wall Street firms themselves try to profit from the tiny differences between the values of the derivatives and the underlying assets.
In recent years, the desks have generated billions of dollars for Wall Street firms. In a research note last year, Kian Abouhossein, an analyst with JPMorgan Chase, said that he expected revenue from the business of about $11 billion this year, growing on average about 9 per cent from 2010 through to 2012.
A reason for the success of this particular desk is the explosive growth of exchange-traded funds an investment class that tracks indexes or baskets of assets. On average, exchange-traded funds are expected to grow about 20 per cent a year, as retail clients, hedge funds and institutions increasingly rely on these products for both exposure to the markets and as protection against volatility.
Also helping the growth of these desks is increased demand from investors for computer program trading, which uses mathematical models to execute lightning-fast transactions.
Delta desks are a profitable business and, on the surface at least, not a particularly risky one. But like many things on Wall Street, the practice can become perilous if not properly policed.
UBS has not provided any details on the trading losses. The UBS trader suspected of the losses, Adoboli, was a director of exchange-traded funds on the Delta One desk in London.
The bank said that trading was being investigated but said "no client positions were affected".
The significance may not be in the trade itself, but in what oversight the bank had on the trader's position or whether the trader hid the risk from compliance officers. It could well have started as a trade for a client where the bank took on a position to make a market that was allowed to balloon. The trade may also have come about after the firm made the market and then decided to hold on, essentially making a directional bet with its own money.
Whatever the cause, the UBS trading losses are likely to rekindle the debate over proprietary trading, which has drawn increasing scrutiny from regulators since the financial crisis.
Yet the definition of what constitutes proprietary trading can be fuzzy. Many on Wall Street consider proprietary trading, or "prop trading", to involve only trades made by dedicated traders who are using the bank's capital and do not have access to client information. The trading done on Delta desks, they contend, is done on behalf of clients.
Those boundaries, however, can blur. A bank may buy a derivative or security from a client in order to make a market, then decide it is worth hanging on to, turning it into a proprietary bet.
Delta One operations are profitable. Societe Generale will generate a return on equity greater than 100 per cent, while the other leader in the business, Goldman Sachs, will generate a return of 52 per cent, according to the JPMorgan report. UBS will notch about 72 per cent.
Frequently Asked Questions about this Article…
What is a Delta One desk and how does Delta One trading work for everyday investors?
A Delta One desk is a trading team that deals in derivatives designed to closely track an underlying asset (the “delta” measures how the derivative moves versus the asset). These products—like exchange-traded funds or index-tracking derivatives—let investors get exposure to baskets of stocks or commodities without buying the physical assets. For everyday investors, Delta One products can offer low-cost, capital-efficient exposure to markets.
What caused the recent UBS $2 billion trading loss linked to a Delta One desk?
UBS reported a roughly $US2 billion trading loss and a London trader, Kweku Adoboli, was arrested in connection with the incident. UBS has not released detailed information on the trades. The article notes possibilities discussed in the industry—oversight lapses, a market‑making position that ballooned, or a trade originally for a client that became a directional bet with the bank’s own capital—but UBS said no client positions were affected and investigations were under way.
How do exchange-traded funds (ETFs) fuel growth in Delta One businesses?
ETFs track indexes or baskets of assets and are popular with retail clients, hedge funds and institutions for market exposure and volatility protection. That explosive ETF growth increases demand for Delta One products and market‑making services. The article says ETFs are expected to grow about 20% a year, and that expanding ETF activity has helped Delta One desks generate substantial revenue.
Are Delta One desks more profitable or riskier than other trading businesses?
Delta One operations are highly profitable on average—the article cites a JPMorgan report estimating roughly $11 billion in annual revenue for the business and strong returns on equity (for example, Societe Generale >100%, Goldman Sachs ~52%, UBS ~72%). On the surface they are not especially risky, but the practice can become perilous if not properly policed because market‑making and client trades can blur into proprietary bets.
What is proprietary (prop) trading and why might regulators be concerned about Delta One activity?
Proprietary trading refers to a firm trading with its own capital—typically by traders who don’t rely on client information. Regulators are concerned because the line between market‑making for clients and prop trading can be fuzzy: a bank may buy a security to make a market and then decide to hold it as a directional bet. Since the financial crisis, proprietary trading has attracted increased regulatory scrutiny, and large losses on Delta One desks can reignite that debate.
How do Delta One desks actually make money day to day?
Delta One desks earn money by creating and trading derivatives that track underlying assets, profiting from tiny pricing differences between the derivative and the asset (arbitrage), market‑making spreads, and by supporting high‑speed program trading. Because many of these products require little upfront capital, desks can generate substantial revenue from volume and automation.
Should everyday ETF investors be worried about bank Delta One losses affecting their holdings?
According to the article, UBS said the trading losses did not affect client positions. Generally, ETFs and their providers operate separately from any single trader’s activities. That said, large dealer losses can prompt regulatory changes or tighter oversight of how banks handle market‑making and proprietary positions—developments investors may want to watch.
Who are Kweku Adoboli and Jerome Kerviel, and why are they mentioned in relation to Delta One desks?
Kweku Adoboli is the UBS trader arrested in connection with the bank’s $US2 billion trading loss and was a director on the Delta One desk in London. Jerome Kerviel is the Societe Generale trader who caused about $US6.8 billion in losses in 2008; he also worked on a Delta One‑type desk. Both cases are cited as examples of how Delta One trading can lead to very large losses when oversight fails.
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