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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