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Billions won and lost in high stakes game

UBS rogue trader may have come unstuck in a currency bet gone wrong, say Liam Vaughan, Elena Logutenkova and Gavin Finch.

UBS rogue trader may have come unstuck in a currency bet gone wrong, say Liam Vaughan, Elena Logutenkova and Gavin Finch.

As Switzerland's central bank imposed a limit on the franc's appreciation against the euro on September 6, UBS trader Kweku Adoboli's Facebook profile had a plea for his friends: "Need a miracle."

Just over a week later, at 3.30am on Thursday, police in London arrested the 31-year-old Ghanaian-born Adoboli on suspicion of fraud by abuse of position.

UBS told investors less than five hours later that "unauthorised trading by a trader" had caused a $US2 billion ($1.93 billion) loss.

Adoboli worked on the bank's Delta One desk, an operation that handles trades for clients, typically helping them to speculate on or hedge the performance of a basket of securities.

It also takes risks with the bank's own money in arranging trades. It was the same kind of desk as the one worked by Jerome Kerviel, who triggered a ?4.9 billion ($6.6 billion) loss for France's Societe Generale

in 2008.

"It couldn't come at a worse time for UBS," said Fred Ponzo, a former trader at Societe Generale and capital markets adviser at Greyspark Partners in London. "The thing is, it's very hard to go through the fail-safes by error. The only way to dig a hole this big is by design. You have to ask the question that if this is a $2 billion hole, is this is a failure of technology and risk management?"

The arrest as global regulators are pressing banks to curb their proprietary trading is likely to revive calls for financial institutions to increase controls on risk and separate their investment banking from their retail businesses.

The loss is "the final straw in UBS's ambitious build-out to a tier-one investment bank", wrote JPMorgan analysts in a note to clients yesterday. "First, we think we'll likely see management changes within UBS's investment bank. Second, we expect UBS will come under pressure from shareholders" and regulators to review its investment banking division.

Shares in the bank, Switzerland's largest, fell 11 per cent following the announcement and Moody's put the credit ratings for UBS under review for possible downgrade.

UBS asked British police at 1am on Thursday to arrest Adoboli, before alerting the financial regulator or prosecutors.

UBS declined to say how the trading allegedly lost $US2 billion. Chief executive Oswald Gruebel called the loss "unauthorised" and "distressing" in an email to employees. No client positions were affected, the company said.

Traders at other firms speculated that UBS may have failed to hedge the currency risk related to an exchange traded fund, known as ETF, or mistakenly placed a currency swap the wrong way.

When the Swiss National Bank, Switzerland's central bank, announced its limit on the currency 11 days ago, the franc fell more than 8 per cent against the euro.

"It's most likely to be a currency trade gone wrong," said Manoj Ladwa, a trader at ETX Capital, a London-based broker that trades stocks, bonds, currencies, swaps and exchange-traded funds. "I would be shocked if it happened over a period of days, because you would expect back-office systems to pick it up. It's only the Swiss franc that's moved so sharply over such a short space of time last week."

Adoboli was a director of ETF and Delta One Trading in London, meaning he was a member of the trading desk. Before that, he worked as a trade support analyst at UBS.

He graduated from the University of Nottingham in July 2003, earning his degree with honours in e-commerce and digital business. He also attended the Ackworth School in West Yorkshire as an overseas boarder until 1998.

"He was an able student who made a very positive contribution to the school community," said Kathryn Bell, head of the school.

Ackworth was founded in 1779 by John Fothergill, an English physician and Quaker preacher. The school still adheres to Quaker doctrines, with students required to attend Sunday worship and engage in "periods of reflective silence".

Adoboli's father John, a retired United Nations employee, said from his home in Tema, Ghana, that his son had made "a mistake or wrongful judgment".

He said: "We are all here reading all the materials and all the things being said about him. The family is heartbroken because fraud is not our way of life. I brought them [my children] up to be God-fearing and to appreciate decency."

Until a few months ago, Adoboli lived in an apartment in London's Shoreditch district. One neighbour remembered him as friendly with a taste for loud parties, who once brought him a bottle of champagne to apologise for the disturbance.

The building, with inscriptions proclaiming it was built as "Soup Kitchen for the Jewish Poor" in 1902, was converted into luxury apartments after the kitchen closed in the 1990s. The district faces the Carter House council estate with its open-air balconies full of rubbish bags, bikes and towels hung out to dry.

The area, with its maze of lanes lined with pubs and restaurants, is where Jack the Ripper struck. On the fringes of the financial district, it is a five-minute walk to the UBS office in Broadgate.

There, Adoboli's desk handled proprietary dealing and trades for clients. Such desks would trade in a variety of securities to enable clients to speculate and hedge baskets of securities. For example, if a client wanted to short Swiss equities expecting the franc to rise, the desk would design a trade and use a combination of equity swaps, futures and ETFs to accomplish it.

As derivatives should mirror the securities they track, they would be insurance against market moves and shouldn't carry extra risk for

the bank.

"Delta One desks are not necessarily known as risky areas," said Terry Smith, chief executive of the interdealer broker Tullett Prebon and asset management firm Fundsmith. "But they are known as complex areas."

Delta One traders profit on cost and margin differences between derivatives and their underlying securities, and by timing the purchase and sale of each element.

The derivatives they use include exchange-traded funds, swaps and futures. Adoboli helped structure ETFs for clients and then hedge the bank's positions to safeguard against potential losses.

ETFs give buyers exposure to illiquid or complex baskets of assets. For example, an investor looking to bet on the movement of London's FTSE 100 index can buy a single ETF rather than individual shares in all 100 companies in the index.

In June last year the Bank of England said there was a danger that "the benefits of ETFs become outweighed by complexity, opacity and contingent risks". The Financial Services Authority said it had "heightened our supervisory vigilance in this area", while in July, the Serious Fraud Office announced a probe into the funds.

"This comes at a critical time in the debate about how to structure the banking system," said Richard Reid, at the International Centre for Financial Regulation. "It makes it much tougher for banks to resist efforts to tighten up regulation just as macro-economic conditions deteriorate."

Market makers

How did UBS let this happen?

Philip Wen, Page 14


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