Trust Me, I'm Not Cheating

Where's the trust? Sometimes, risk management just comes down to a basic level of trust.

This past week I was in Chicago for Inside Market Data's annual Chicago-focused event. On Tuesday, a few days before UBS' Kweku Adoboli alleged mutiny that may cost the bank $2 billion came to light, I was speaking with Dr. Euan Sinclair, the risk manager of prop-trading shop Bluefin Trading.

I found what he told me to be very interesting: More important than any technological solution for risk management is the simple concept of trust. Specifically, the traders need to trust him; they need to know that he will have their best interests in mind. Sinclair gave me an example where despite having a robust infrastructure in place to monitor risk and detect violations, it's impossible for any trading firm's systems to be full proof.

The funny thing is that Sinclair was adamant-even though he's the risk manager-about providing an environment so that he doesn't stand in the way of his firm making money. He trusts his traders, so when they come to him to propose entering into a potentially risky position, he will likely green-light the strategy as long as it fits inside the firm's risk parameters. Not all bets will pay off and there will be loses, that doesn't mean that you run and hide or slap an ambitious trader down.

The only times when problems arise are when traders hide their true intentions from him.

This is always going to be an uphill battle for risk managers. If your systems are too invasive, if your risk management practices are too timid, it creates a tough environment to make money. That's what this business is all about-making money. In that kind of environment, fraud will happen. That's not to say that it will happen at every firm, or that it should be tolerated, but it will happen and that doesn't always mean that a firm failed its employees and investors by skimping on technology.

It's such a simple concept, but we all seem shocked every time a rogue trader comes to light. Be sure that these things happen on a far smaller scale ($2 billion?!) all the time, but because they happen at private companies they can be more easily swept under the rug and the losses can be contained. No one is immune-sometimes even if you have the most pristine IT in place.

The shame the fraud that has transpired at UBS is not the loss of money; it's the loss of jobs that may result in response to this crime if UBS scales back its investment banking operations.

This will be an ongoing war as the art of trading becomes more automated and conducted at speeds that are monitored in microseconds and eventually nanoseconds.

Technology can be a very valuable weapon in this war-both offensively and defensively-but the same way that software can't feel emotion, technology will always be at a disadvantage when it comes to monitoring broken trust.