THE UK’S financial and markets regulator has released guidance on controls that financial institutions should be checking to avoid losses experienced by SociétéGénérale in January.
Following discussions with around 40 to 50 of the largest trading banks operating in London, the Financial Services Authority (FSA) said many were reviewing controls.
“The current volatile market circumstances significantly heighten the chances that inappropriate practices could quickly lead to record losses, so early discovery and remedial action are even more important than in ‘normal’ times,” the FSA says in it’s latest Market Watchreport, which includes 11 recommendations.
These included culture and governance checks; assessments of trading mandates and limits; making sure those responsible for controls have sufficient skills to challenge the front office; ensuring all risks are captured, checking how well information is pooled on a daily basis between separate oversight teams, and then escalated to deal with suspicious activity; systems to check whether large profit and loss movements make sense; and ensuring management information is sufficient to track the risk profile of confirmations.
“Clearly, transactions between firms have to be confirmed to make sure positions booked on a firm’s systems are accurate and firms should also consider the confirmation of internal trades,” the FSA said.
“However, firms should think about whether they have a framework in place to track and analyse outstanding confirmations together with a process for escalation to senior management if the service-level agreements are not adhered to.”
Jerome Kerviel is alleged to have falsified confirmations of hedges against his trades, but many have questioned how his supervisors didn’t pick this up through routine checks.
For office culture and governance, the FSA said firms need to look at the quality of routine management information and exception reports to trading management, as well as ensuring there are rewards and clear incentives for front office management to enforcing adequate controls.
“Firms should also consider whether the front office culture is designed to prevent ‘rogue trader’ activities,”the report advised.
“For example, are traders encouraged, or required, to take two-week continuous holidays?”
It also said “desk holidays” should also be considered, where a colleague takes over marking or valuing their books.
Understanding the reasons for the profit and loss (P&L) made per day was also very important. “P&L attribution is a key control for understanding risk in a trading operation as the P&L is the outcome of the risk taken,” the FSA said. “So, understanding where the P&L is coming from is very important for firms, especially where more complex products or basis risks are traded.”
The regulator also said their needed to be formal checks, or reconciliations, to ensure confirmations and positions are consistent between the front-office, risk management departments and the back-office controls, and with the outside world, including confirmations and reconciliations with nostro accounts (commonly, foreign currency denominated accounts maintained with foreign banks to settle foreign currency transactions), exchanges and brokers.
Prosecutors in France have reportedly questioned a Société Générale colleague of Jerome Kerviel as part of their investigation.
The New York Times reported this followed the questioning of Moussa Bakir, a broker at Fimat who brokered a number of cash equity trades for Kerviel.
Reports have suggested Kerviel is also planning to sue his former employer for being sacked for gross misconduct, but his lawyer had refused to comment on the speculation when Risk Management was going to print.