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Are Banks Reassessing Risky Practices in Wake of Libor Scandal?

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Yesterday in London, executives of the Royal Bank of Scotland testified in front of a Parliament commission of banking standards. The topic at hand was of course the much-publicized Libor rate-rigging scandal that cost RBS more than $600 million in fines from the UK’s Financial Services Authority, the U.S. Commodities and Futures Trading Commission, and the U.S. Department of Justice.

In the hearing, CEO Stephen Hester was quick to note that the scandal was the product of unscrupulous behavior by the firm’s employees. “The behavior was the disgraceful failure of individuals,” testified Hester. But he also didn’t hide from the fact that his company failed to detect the rate rigging. “We were slow to recognize that behavior and catch it,” he said at the hearing.

The FSA’s director of enforcement and financial crime, Tracey McDermott, put it a little more strongly. “During the course of the FSA’s work on Libor, RBS provided the FSA with an attestation that its LIBOR related systems and controls were adequate,” said McDermott in statement. “This was not correct. The FSA takes it very seriously when firms tell us they have appropriate systems but do not.”

McDermott went on to point out the effect that all this has on whole investment banking sector. “The extent and nature of the misconduct relating to Libor has cast a shadow on the reputation of this industry, and we expect firms to take steps to ensure that this can never happen again. This is the third penalty we have imposed in relation to Libor-related misconduct. The size and scale of our continuing investigations remains significant.”

John Hourican, who headed RBS’s investment banking division before resigning last week, said that the taxpayer-bailed-out bank was on “cardiac arrest” given all the troubles that began in 2008, so it had to “prioritize dealing with the existential threat to the bank.” That is what may have led to the breakdown in controls that subsequently led to the rate rigging going on under management’s nose.

The company was simply too busy dealing with other, more-pressing threats to pay any attention to what a rate-rigging possibility that some in the bank considered an impossibility.

According to a Wall Street Journal report, former investment banking head John Cameron believes this left the company exposed to a type of behavior not unexpected of traders.

RBS’s former head of investment banking, Johnny Cameron, who left the bank in early 2009, said traders at banks involved in the attempted rate manipulation had more in common with each other than other bank workers, and that their behavior seemingly had little to do with the firms they worked for.

It is “as much about the culture of traders and people who trade things than any bank,” Mr. Cameron said in his testimony to the committee.

He said RBS’s risk managers failed to recognize the potential for traders to influence submissions used to help set interest-rate benchmarks, and that the failure highlighted why traders need “tight and close management.”

“I do think that traders have a particular approach to life and need much tighter controls. By and large, those controls are imposed. What happened in this case was that the risk managers didn’t recognize this as a risk, and those controls were not there,” Mr. Cameron said.

In short: traders are going to be traders and somebody needs to be watching them — but, in this case, nobody was.

Perhaps that vulgar reality about the banking world is what is motivating two other financial sector giants to move away from some of their riskier trading activities, according to the New York Times blog Dealbook.

First, it has this to say about Barclay’s recent decision to lay off 3,700 employees.

Barclays announced a major restructuring that will eliminate 3,700 jobs and close several business units, as the bank reported a big loss in the fourth quarter of 2012.

The overhaul of its operations comes after a series of scandals at the bank, including the manipulation of benchmark interest rates, which led to the resignation of the firm’s former chief executive, Robert E. Diamond Jr.

In a bid to reduce its exposure to risky trading activity, Barclays plans to close a number of operations in Europe and Asia, including a tax-planning unit that has been criticized for tarnishing the firm’s reputation.

“There will be no going back to the old way of doing things,” the chief executive, Antony P. Jenkins, told reporters at a news conference in London on Tuesday. “We will never be in a position again of rewarding people for activities inconsistent with our values.”

Then, Dealbook notes the following regarding UBS’ decision to part ways with the former head of its investment banking.

Carsten Kengeter, the former head of UBS‘ investment bank, has been on the outs at the Swiss banking giant for some time. On Tuesday, the bank announced that he was resigning.

Mr. Kengeter has been head of the bank’s non-core division, which oversees the assets that the bank is hoping to unload as it tries to exit higher risk banking activities.

But when he was running the investment bank, Kweku M. Adoboli, a trader in the London office, was accused of authorized trading that led to a $2.3 billion loss for the bank. Mr. Adoboli  was eventually found guilty of fraud and sentenced to seven years in prison.

The trading loss raised serious questions about the firm’s oversight and led to the resignation of  Oswald J. Grübel, the chief executive of UBS. Also during Mr. Kengeter’s time at the investment bank, UBS became ensnared in an investigation into the manipulation of the global interest rate benchmark Libor, or the London interbank offered rate.

There may be no direct thread running through these announcements.

It could all be a coincidence.

But as regulators continue to scrutinize those who fail to detect the risky, illicit behavior of those working within their firms, it seems as though some banks are starting to embrace the risks of their core business over those that are more difficult to oversee.

Systemic Risk Management

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On the three-year anniversary of the Lehman Brothers bankruptcy — and with it, the beginning of the financial crisis that threatened a run on at least a dozen major global banks — a rogue trader was discovered to have defrauded his employer, the Swiss bank UBS, of nearly $2 billion.

What’s $2 billion between former friends, you might ask?

Indeed.

$2 billion isn’t going to bring down a bank of UBS’ size. $2 billion isn’t going to ignite another downward spiral of credit payments coming due. $2 billion isn’t going to hurt that badly, even if UBS is now reporting that the incident may cause it to go into the red for the third quarter.

So more than anything, what this undetected fraud highlights is just how poor the risk management still may be at one of the world’s biggest banks. And coincidentally — or perhaps not so much so — the head of risk for UBS was formerly the head of risk for Lehman.

“It’s astonishing given the technology, the systems, the emphasis on risk. UBS has been focusing on it, post-crisis they’ve put more focus on it than a lot of other banks,” the industry source said.

“I’m surprised that this many years after [previous rogue trader] Nick Leeson there are still the Jerome Kerviels of the world and now this one. How does a 31-year-old rack up a $2 billion loss without anybody noticing?”

Others said the crisis showed lax supervision at UBS and threw the spotlight on an industry that will always compel some staff to take excessive risks to keep ahead of rivals.

“No rogue trader works in a vacuum, and UBS’s management must have taken its eye off the ball to allow a trader to operate on this scale without sufficient supervision and without the systems to monitor his trades,” said Simon Morris, a partner at UK law firm CMS Cameron McKenna.

Worse still is the fact that UBS is unlikely to be the one isolated financial firm that has dragged its feet in implementing better protocols to avoid, or at least discover, threats. No, many of its peers are likely also not yet as far along as they should be — three years later.

Fortunately, some of the laws mandated by the Dodd-Frank financial sector reform act are starting to kick in. It remains to be seen if these new rules will help, but one of them mandates companies to create a plan that will help officials (namely, the FDIC) unwind and deconstruct complex transactions in the event they go belly up.

Submitting these plans, which have been called “corporate living wills,” is essentially giving the government “Tell Me How You Will Fail” blue prints.

The New York Times blog Deal Book breaks down the concept.

The basic idea is simple: big financial companies have to submit plans that explain how they would structure a future bankruptcy case or orderly liquidation authority proceeding if they were failing. The plans have to be written for two scenarios: one in which a financial institution alone fails, and one in which it fails as part of a broader crisis. In addition, financial institutions would have to disclosure their exposure to other significant financial companies.

The wrinkles start to develop when you see that the rules provide that the plans have to be made with an assumption of no governmental funding. That makes sense given how Congress has restricted the Federal Reserve’s §343 powers as lender of last resort, but it is not very appealing, especially for the systemic crisis scenario.

If not the government, precisely who is going to provide funding when the bankers are in severe trouble? And how precisely do you pay for a bankruptcy case — even a Chapter 7 liquidation case — with no funding? It probably involves the equivalent of leaving a failing bank in a vacant lot in Newark.

As Deal Book blogger Stephen Lubben notes, the schedule of this whole exercise means that finalized plans may not be on file with the FDIC until 2014. That, as well as more fundamental issues some have raised, make this an imperfect method to manage systemic risk in the financial system.

But considering that the government was making no attempt to manage systemic risk in any systematically way prior to the crisis, this can at least be considered progress.

As for whether or not it is a solution to the next global financial crisis that threatens to drag the world into a replay of the Great Depression, hopefully we will never have to find out.

Another Rogue Trader for the Record Books

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Since 2008, investment banks have taken quite a beating. From huge subprime losses to dwindling trust of consumers. And now, they can add another notch to their belt.

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Today, Swiss bank UBS announced that a rogue trader in its investment bank had lost $2 billion on unauthorized trades.

The incident raises questions about the bank’s management and risk policies at time when it is trying to rebuild its operations and bolster its flagging client base. The case could also bolster the efforts of regulators who have pushing in some countries to separate trading from private banking and other less risky businesses.

The trader, 31-year-old Kweku Adoboli, was arrested by UK officers though exact charges have not yet been announced.

You may remember a similar case involving Jerome Kerviel, a former trader at French bank Societe Generale, who defrauded the company by gambling away $6.7 billion. He single-handedly brought the 145-year-old bank to near bankruptcy when the trades were discovered in January 2008. He was charged and convicted of breach of trust, forgery and unauthorized use of the bank’s computer system.

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Will Adoboli be charged with the same? More importantly, why didn’t the largest bank in Switzerland learn from the Societe Generale case, which went down in history as the biggest rogue trading scandal in history?

“All men make mistakes, but only wise men learn from their mistakes.”
-Winston Churchill

Big Companies Not Managing Water Scarcity Risks

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water scarcity

Despite recent scrutiny of some large corporations that rely heavily on water resources, it seems many companies are still falling short in managing and disclosing water scarcity risks. That’s according to a recent report issued by the Ceres investor coalition, the financial services firm UBS and financial data provider Bloomberg.

The report evaluates and ranks water disclosure practices of 100 publicly traded companies in eight key sectors exposed to water-related risks. The report shows that many companies are not including material water risks and performance data in their financial filings, nor are they providing local-level water data, particularly in the context of facilities in water-stressed regions. Moreover, none of the 100 companies are providing comprehensive water data on their supply chains, an especially glaring omission given that the vast majority of many corporations’ water footprint is in the supply chain.

The report uses a scoring scale of 0 to 100 with the three highest scoring companies being UK beverage company Diageo, Swiss mining company Xstrata and U.S. electric power company Pinnacle West (owner of Arizona Public Service).

“Most companies provide basic disclosure on overall water use and water scarcity concerns, but their focus and attention so far is not nearly at the level needed given the enormity of this growing global challenge,” said Mindy S. Lubber, president of Ceres. “Our global economy runs on water and in many parts of the world this finite resource is under threat. Companies must do more to disclose their potential exposure from this issue and their strategies for responding.”

The report assesses companies in eight different sectors: beverage, chemicals, electric power, food, homebuilding, mining, oil and gas and semiconductors. The report found the following:

The mining sector scored highest overall, followed by the beverage industry. Companies in the homebuilding sector had the lowest overall scores.
Only 21 companies disclose targets to reduce water use, and even fewer – just 15 companies – had goals to reduce wastewater discharge.
Only 17 companies report local-level water data and only a handful provide the information in the context of operations in water stressed regions.
  • The mining sector scored highest overall, followed by the beverage industry. Companies in the homebuilding sector had the lowest overall scores.
  • Only 21 companies disclose targets to reduce water use, and even fewer — just 15 companies — had goals to reduce wastewater discharge.
  • Only 17 companies report local-level water data and only a handful provide the information in the context of operations in water stressed regions.
The findings in this report do not bode well for companies with the highest scores. Investors have been increasingly critical of companies that do not disclose environmental, social and governance risks they may face. It is nice to see that this report offers a bit of guidance for those companies wanting to be more transparent with such risks. It recommends companies:
  • include material water risk factors and performance data in their financial filings;
  • provide water performance data broken down to the facility level for operations in water-stressed regions;
  • outline actions and policies for assessing and managing water risks, including quantified targets for reducing wastewater and water use;
  • disclose how they are collaborating with stakeholders and suppliers on water risks, including setting performance goals for key supply chains;
  • outline specific strategies for developing water-related products with strong market potential in a water-constrained world.

For more about water scarcity, check out the cover story we ran in our June 2009 issue. And please, let us know how your company is managing water scarcity risks.