So-called rogue trading encapsulates what many people believe are the most grievous defects of the modern banking and finance system. It certainly calls into question the culture of victim organisations and the management standards of the leaders of those organisations.
Rogue trading is simply unauthorised or prohibited trades. It involves the trading of various kinds of financial instruments or interests, usually in an environment where transaction volumes are large and the aggregate value of trades are high so that the potential losses can get out of control very quickly.
It is tempting to see rogue trading as the consequence of poor organisational culture and inappropriate management behaviours and attitudes. While rogue trading can reflect no more than the absence of effective controls and an inability (or unwillingness) to recognise and deal with obvious risk factors, it can also occur as a result of a failure to consider how deception can be used to circumvent controls and ultimately detection.
At KPMG we see a range of factors associated with a heightened risk of rogue trading.
- No formal policy or documentation
- Manual sign-offs
- Generic mandates, roles and responsibilities.
- Limited/nil risk analysis of unconfirmed trades
- Multiple errors.
- Poor links between internal records and external balances
- Manual reconciliations
- No formal escalation process.
- Limited risk analysis
- High-level allocation of LCA trades.
- Poor balance sheet data and/ or lack analysis
- Limited risk assessment
- No obvious clearance of issues/breaks/differences
- Manual generation of P&L data
- Poor/inconsistent granularity of reporting.
- Limited application of variance limits
- Lack of pricing hierarchies
- Internal validation of models not applied
- Insufficient reporting/monitoring of unverified positions.
- Monitoring of net limits only
- No intraday monitoring
- High-level limits, not set with respect to underlying trade activity.
- Lack of monitoring of rogue trader hotspots
- Poor prioritisation of issues
- Insufficient documentation of RACI and key controls
- Limited application of deceptive trade monitoring indicators.
- Insufficient clarity around front office risk and control
- Lack of front to back office control ownership.
Many of these defects are relatively straightforward to remedy, although they do take time and money to get right. Rogue traders are usually taking advantage of fairly basic control gaps and holes, and because rogue traders find ways to circumvent primary controls, ‘secondary’ controls (funding analysis, balance sheet movements, late bookings, unconfirmed trades, etc.) become critical.
Breaches of trading procedures should always be followed up and the offenders punished, even if loss is limited or an insubstantial profit is generated.
While we hear a lot about toxic trading room cultures, we hear much less about the management practices and control processes that allow them to flourish. Organisations that experience rogue trading are rarely the victims of fiendishly clever criminal masterminds, but are suffering the consequences of failures in risk recognition and control.