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UBS, or the Comedy of Repetition
Philippe Messager, Chairman, AFTE – The French Association of Corporate Treasurers
In the space of a few hours, Kweku Adoboli became as famous as Nick Leeson, Bernard Madoff and Jérôme Kerviel. Without breaking Mr. Kerviel’s record for losses, the UBS trader cost the Swiss bank nearly €2bn. How did he do it? By processing transactions on the ETF (exchange traded funds) market, and more specifically on the synthetic ETF market. ETFs are investment funds that look to reflect the performance of a benchmark index. They are listed index products that grant the bearer either their underlying securities positions (physical replication) or that of derivatives (synthetic replication). Synthetic ETFs are based on a yield swap agreement with a counterparty. The latter determines the basket of securities. By nature, the price of synthetic ETFs can differ from that of its underlying, not only because of the intrinsic performance of each asset making up the underlying, but also the value of the CDS (credit default swap) purchased to insure against the counterparty risk represented by the party with whom the swap was implemented. In this case, these risks are not added together, they are multiplied!
How is it possible that such an event could come to pass, and on such a scale, a mere three years after the Société Générale scandal? How could a major bank drift so far off course? And most of all, what lessons can companies learn from this development?
On the UBS side, the assessment is triply distressing:
1 - Incoherence between words and actions
Indeed, UBS declared to its wealthy clients on July 27, 2009 that “the short-term nature of synthetic ETFs goes against the long-term philosophy that UBS recommends in designing its clients’ portfolios”.
2 - Pusillanimity of the Group CEO
Oswald Grübel, Group CEO of UBS (nicknamed Saint Ossi, since he was appointed to this position to save the bank after the subprime disaster that had cost more than €30bn) admitted responsibility, but not guilt. Like others before him when confronted with this kind of crisis, he firmly and clearly announced his intention to remain at the head of the Group. In the end, GIC, the Singaporean sovereign wealth fund that owns 6.41% of the capital of UBS, decided otherwise.
3 - Failure of internal and external monitoring bodies
Everyone thought the Kerviel scandal had sounded the death knell for such iniquity among bankers, but that is obviously not the case. Moreover, this incident once again sheds light on the inability of auditors to discover fraud when it concerns complex instruments. The event also serves to illustrate that regulators lack the means to properly determine the risks that complex products impose on banks, their shareholders and their clients. Thus the legitimate question: How can we be sure that in the future no bank will experience losses of this magnitude?