The how but not why of UBS's losing bets

UBS UBS say the size of the bets was hidden by fictitious offsetting investments

Hello from balmy China, where I am making a two-part documentary on the 15 years leading up to our current economic malaise and the next 15 years.

(When I say "our", in this context I mean the heavily indebted, slow-growing developed economies of the west).

As luck would have it, UBS's synopsis of how it incurred a $2.3bn (£1.5bn) loss from unauthorised transactions by an alleged rogue trader, Kweku Adoboli, landed in my inbox just as my aeroplane to Shanghai took off.

So here are a few thoughts from the plane, whose communication to you is all due to the refusal of cabin staff to let us sleep (I bet you're pleased).

First, I am not surprised that the size of the loss has turned out to be 15% greater than UBS first estimated - because selling or hedging big trading positions in a hurry, as UBS had to do on Friday, is always expensive.

Second, what UBS has provided is useful detail about the mechanics of the transactions - and why it failed to identify them till it was too late to avoid a colossal loss - but important questions remain unanswered.

For the past three months, big bets were placed on future movements in stock-market indices, the S&P 500, the Dax and the EuroStoxx. This was speculation on the future direction of share prices.

According to UBS, the size of the bets was hidden by the manufacture of fictitious offsetting investments via financial products called Exchange Traded Funds.

To put it another way, the impression was created that UBS was taking no more risk than usual, when in reality it was taking huge risks on stock-market bets.

So from mid June to last Wednesday, UBS's risk-control systems did not detect that these big bets were being placed, because its internal accounting system was showing that bets in the opposite direction had also been placed.

Think of it as the equivalent of a bookmaker placing bets with his firm's cash, and only pretending to lay off those bets with other bookmakers - which would be financial suicide if the real bets were not to come good.

So we have a slightly better idea of how the bets were taken and how UBS missed them. But it doesn't explain why the bets were taken.

Rational motive

Here's the thing: if the bets had been winning bets, rather than losing ones, surely at that point UBS's internal controls would have detected that the bank had made winnings considerably bigger than it should have done, in that the winnings should have been reduced by losses from the offsetting bets but would not have been (keep up).

In other words, the existence of big winnings would surely have set alarm bells ringing that the offsetting nets were fictitious.

Which means that it is very difficult to detect a rational motive for the taking of real bets matched by offsetting fictional ones, because it is very difficult to see how any individual could have profited by such a stratagem.

For example, by the time bonuses were being decided, surely the fictitious transactions would have come to light.

Unless, that is, there is never any moment at huge banks like UBS when book profit is reconciled with cash profit - so that all profit is only what is shown by the internal accounting system, even if some of the entries in that accounting system are fictional.

Anyway, it is all very intriguing - and shows that UBS has a good deal of work to do, to prove that its risk monitoring systems are adequate.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 21.

    To Lindsay @ No.1

    "Well it's pretty good in Switzerland matey!"

    Isn't this the major flaw with a globalised banking system that a major fraud/loss at the Union Bank of Switzerland leaves those in Switzerland feeling cheerful whilst the U.K frets?

  • rate this

    Comment number 20.

    "here are my thoughts" .... "but important questions remain unanswered"

    Mr Peston with these words you seek to reassure us. But that is mendacious, the entire financial industry is just a way to funnel money into the pockets of a few clever bankers whilst contributing nothing whatsoever to society.

    A scheme like this requires the cowardice of journalists to support it.


  • rate this

    Comment number 19.

    So I take a bet that things will go up 5%. To offset my risk I take a bet it will go down 5%. Only one can be true, the profits from one are offset by the losses form the other. How do I make money? Surely I'm just living off the taxing of the transactions and or scamming someone who is less well informed or not as quick as me? How can this be an honest living?

  • rate this

    Comment number 18.

    Comment number 17.John_from_Hendon
    Why don't you write an external blog to explain how this works. I'm keen to understand the thinking which you can't do in 400 characters.

  • rate this

    Comment number 17.


    The ONE enormous obstacle to getting the western World back to work is the near absolute refusal to learn anything from economic history.

    The main lesson is that before all recoveries (see above) FIRST the DEBT BUBBLE has to be deflated.

    Yet all policy is directed towards increasing and maintaining non-performing debts!

    Interest Rates up to a rational level (5%) is the FIRST step.

  • rate this

    Comment number 16.

    'I was mugged by a sweet little old lady. And I didn't even see it coming' to paraphrase Lloyd uin Dumb and Dumber - a film that should inspire the banking community onto aspiring to such intellectual achievement.

    A bent system run by crooks for the benefit of crooks that treats the rest of the world like morons.

    'Lessons will be learnt' , a phrase that once more we will here ad nauseam.

  • rate this

    Comment number 15.

    Somebody has this 1 - 2bn (3bn as its increasing daily!?!) - have you checked your bank balances recently?!

    It ain't in my accounts - so come on - who has it - hands up!

    YOU CANNOT JUST LOOSE 2 to 3BN without a paper trail, surely?

    Someone has it.

    Maybe Shirley does have it?!

    I'm taking my investments and they are going back under the mattress,

    Safer there!

  • rate this

    Comment number 14.

    The Why Q is easy...Greed.

    The remaining point about what happens when the bets come good is extremely valid. You never hear of a trader being sacked or arrested for making a profit.

    I suspect he is given a slap on the wrist, told not to do it again and an even bigger slap on the back and handed a big juicy bonus. Other egotistical traders see that and hey presto, Greed culture is born.

  • rate this

    Comment number 13.

    Auditors (internal and external)

    All to blame.

    This was/is an out of control bank and should have its licence removed.

  • rate this

    Comment number 12.

    It would seem that the major financial institutions are run by people with the same mindset as the social service agencies who appear in court after yet another abject failure of care and mutter the tired mantra "lessons will be learnt". They never seem to be, do they?

  • rate this

    Comment number 11.

    "I'm responsible for everything that happens at the bank," Mr Gruebel told Swiss Sunday newspaper, der Sonntag. "if you ask me whether I feel guilty, then I would say no." Neatly, the problem with Finance that I highlighted on the last blog. Same old faces making the same mistakes and accepting no blame. The taxpayer supports the people who caused the disaster and business carries on as usual.

  • rate this

    Comment number 10.

    I think it is an insult to call it casino banking. In a casino you know the risks. This is more like an illusionist or magician. You know that you are being fooled but can't quite work out how.
    What ever the tricks are, the auditing should deal with the basics of money in and money out with value decided by the market - if it isn't fast asleep.

  • rate this

    Comment number 9.

    If as you say real transactions can be masked by fictional ones then surely this illustrates the inadequacy of the system and it needs to be addressed.
    If the "bets" had been a success does this mean that if the scam had been discovered it would have been swept under the carpet ?
    If this is the case and the wins outnumber the losses does this indicate collusion ?
    This could be a can of worms.

  • rate this

    Comment number 8.

    I wonder whether we would have heard anything at all about this if UBS had won the 'bets'. I think a quiet word and a slap on the wrist for the trader would have been the end result.

  • rate this

    Comment number 7.

    "Unless, that is, there is never any moment at huge banks like UBS when book profit is reconciled with cash profit"

    Obviously not at UBS. Traders should never be allowed to calculate their own profits.

    Leave that to the finance function.

  • Comment number 6.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 5.

    Never mind internal monitoring because it reads like there is a fundamental accounting systems fault which should come to light through professional audit? So what have UBS auditors been up to. Also is not the problem that traders who get individual bonuses are effectively unsupervised and those with the right internal specialist knowledge can get away with financial murder? Ring fences wont do.

  • rate this

    Comment number 4.

    Lessons learned or carry on regardless? I suspect the latter. What useful product or service is being provided by all this casino activity that soaks up so much money and well-educated human talent that could be put to productive use. The modern Western economy is become a Ponzi scheme. Surely we must end this madness and return banking and investment to productive services of the real economy?

  • rate this

    Comment number 3.

    If the fictitious transactions were external, then confirmation matching procedures were non-existent.

    If they were internal (with another trading desk) then internal matching systems were non-existent

    Either way, they can't prove "adequacy" of internal controls. They couldn't even agree to the general ledger.

  • Comment number 2.

    All this user's posts have been removed.Why?


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