Rogue Trader Risk

When talking about "rogue trader", in the past you will associate it with the Barings incident, now new scene has been played by Societe Generale. I never believe that a rogue trader could really kill a firm if he is not "empowered" by the blind management and lax controls.

Recently FSA published a Market Watch paper which focuses on firms' reviews of their systems and controls in light of SG's rogue trader incident. The paper highlights the measures firms should consider to protect them against rogue trader risk. In the current volatile market environment, with the risk of inappropriate practices quickly leading to significant losses, early discovery and remedial action are even more important than in more benign conditions.

The following suggestions made by the Market Watch are remarkable:

• If a trader has a high number of cancelled and amended orders in a period, firms should consider if this would be brought to the attention of senior trading management and control functions through routine reporting.
• Traders should be encouraged (or required) to take two-week continuous holidays (i.e. block leave policy).
• Use of suspense accounts should be understood by middle and back office, and challenged when used inappropriately by front office.
• Firms should monitor those risks that may be difficult to capture as part of a portfolio or firm level risk measure, e.g. exotic and higher order risks, basis risks and liquidity risk.
• A number of "yellow" flags in different areas should be aggregated to produce a "red" flag if there are common control concerns with a particular trader across different areas.
• Transactions done at an "off-market" rate should be checked because an attempt to alter profit and loss may require the trader to enter trades at an off-market rate.
• Confirmations or valuations should be sent directly from external counterparties to the middle or back office, not via the front office.
• Location checks should be performed to detect whether a front office person is logging into a computer in the back office.

In substance, I think rogue trader risk is a risk resulted from a poor corporate governance environment.