Frontiers in finance magazine - February 2012

Frontiers in Finance Rogue trading Brazil
For decision makers in The factors necessary The new hot spot for
financial services to form an effective investment management
February 2012 control framework Page 8
Page 12

Frontiers
in Finance

Forging forward:
Financial services
in 2012
Insurance
Finding growth opportunities
in uncertain times
Page 22

FOREWORD

FORGING FORWARD:
FINANCIAL SERVICES
IN 2012

From the
Editorial team
At frontiers in finance, we have always tried The turmoil in our industry shows no
to live up to the promise of the magazine’s sign of abating. The worst dangers of the
title: to present for the benefit of our clients financial crisis have given way to political
and other readers leading opinions and analysis and regulatory reaction on perhaps an
addressing issues at the cutting edge of the unprecedented scale. But major uncertainties
financial services industry. We have also remain. Banks, insurers, investment managers
tried to do this in the most succinct and – all face a future which will be as different as
accessible manner. it is currently obscure. The articles in this issue
of frontiers review regulatory developments
A change of editorial responsibility is from a number of perspectives; we look at
traditionally a time to take stock, to review growth prospects in the insurance sector and
and to refresh a publication, and this is what in the massive but still emerging market of
we have been doing. We have sought Brazil; operational issues addressed include
feedback from the tens of thousands of how to guard against rogue trading and how
readers we serve, both within KPMG and in to implement effective customer remediation
the wider financial services community. It is when things do go wrong.
gratifying to find that in the main we have been
living up to our promise. Many of you have There is more. But we hope you find it a
emphasized the value of the magazine. stimulating and helpful guide through the
complexity of today’s, and tomorrow’s,
At the same time, just as the financial financial services industry.
world is changing, there are ways in which
frontiers needs to evolve as well. We still
aim to provide a commentary on the key
financial services topics of the day which
is both relevant to your business and your
challenges and also offers practical guidance
and solutions. In future, we hope to be a little
more forward-looking, perhaps clearer and
more concise, and to pay greater attention
to cutting through the complexity which
can bedevil financial services. We shall be
including two or three more regular features,
and trying to provide a rather stronger thematic
underpinning to each issue.

© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

FRONTIERS IN FINANCE FEBRUARY 2012

CONTENTS FEATURES

COLUMNS

02
Chairman’s message
Global Financial Services
Chairman points out that
while western markets face
several challenges, there are
opportunities and growth in
many parts of the world.

04
Regulation matters
Regulation of the global financial
services industry is evolving
rapidly, on many fronts and in
complex, overlapping ways.

20
Cutting through concepts
A new recurring section
which seeks to bring clarity
around complex and often
misunderstood financial
services concepts or issues.

14
8 22
Produced by KPMG’s Global Financial
Services Practice Brazil Insurance
Designed by Mytton Williams The new investment Finding growth opportunities
Publication date: February 2012 management hot spot. in uncertain times.
Publication number: 120182

18
Printed on recycled material
12
The information contained herein is of a general Rogue trading

8
nature and is not intended to address the The actions and approach to
circumstances of any particular individual or entity.
Although we endeavour to provide accurate and
reduce the risk.
timely information, there can be no guarantee
that such information is accurate as of the date it 14
is received or that it will continue to be accurate in Customer remediation
the future. No one should act on such information
without appropriate professional advice after a
Getting it right once you
thorough examination of the particular situation. have got it wrong.
INSIGHTS
© 2012 KPMG International Cooperative (“KPMG 18
International”), a Swiss entity. Member firms
of the KPMG network of independent firms
26 Basel III
are affiliated with KPMG International. KPMG Updates from KPMG member The issues and implications of the
International provides no client services. No firms, thought leadership and capital adequacy guidelines.
member firm has any authority to obligate or bind contacts.
KPMG International or any other member firm vis-
à-vis third parties, nor does KPMG International
have any such authority to obligate or bind any
member firm. All rights reserved. Printed in the
United Kingdom.

The KPMG name, logo and “cutting through
complexity” are registered trademarks or
trademarks of KPMG International.

COLUMNS

CHAIRMAN’S MESSAGE

KPMG’s Global Financial Services Chairman points out
that while western markets face several challenges, there
are opportunities and growth in many parts of the world.

Opportunities in
a Changing World

A
s we publish this issue of In addition to adapting to new regulation, banks
frontiers in finance, the financial continue to face the perennial challenges of
and economic environment managing operational risk and implementing
remains fragile in many parts transparent and robust remuneration policies.
of the world. Financial sector Both areas continue to come under significant
firms face an unprecedented combination scrutiny from governments and regulators.
of threats from the lack of GDP growth, a Amidst the despondency in Europe it is
Jeremy Anderson lack of confidence in the European bank easy to forget that many countries are growing
Global Financial Services Chairman and sovereign debt markets, and calls for apace. There are tremendous opportunities to
additional capital and liquidity as part of the grow in Asia, South America, India, and also on
sweeping changes impacting many parts the African continent, where the convergence
of the financial sector globally. We remain a of banking and mobile telephony is creating
long way from durable solutions to the crisis. unprecedented opportunity.
While policymakers around the world As financial institutions rise to the
have responded differently to these threats, challenge of providing banking and insurance
on balance the global response has been to services to more than two billion ‘unbanked’
increase austerity measures. What is not yet people globally, a key focus will be how to
clear is whether austerity objectives will be achieve this sustainably, so that the financial
able to deliver the renewal in confidence and sector is seen as a partner in responsible
growth that are needed to emerge from the development. To this end, KPMG is organizing
current crisis. At the same time the banks are a global conference to articulate a Business
being required to hold more capital with the Perspective on Sustainable Growth ahead of
attendant risk to new credit origination. the Rio+20 summit in June 2012.
The pace of regulatory change this last Whether your immediate focus is on the
year has been relentless, driven primarily Eurozone and regulatory developments or on
by the G20 Financial Stability Board, in the tremendous opportunities in high-growth
the form of requirements for G-SIFIs, the markets, I hope you will find this edition of
implementation of Dodd Frank in the frontiers in finance stimulating and useful as
United States, multiple European Union you launch into 2012.
regulations, and an emerging focus on
consumer protection.
Rarely have we seen executive teams
spend so much of their time grappling
with regulatory issues. Change programs,
impacting people, processes and technology,
need to be implemented in parallel, across
multiple regions and jurisdictions and under
different regulatory frameworks. This is a
profound challenge for even the most agile
financial institutions.

2©/ 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
Frontiers in Finance / February 2012

COLUMNS

REGULATION ROUND TABLE

Regulation of the global financial services industry is evolving rapidly,
on many fronts and in complex, overlapping ways. In this new recurring
section, the heads of KPMG’s three Regulatory Centers of Excellence –
Giles Williams (EMA), Simon Topping (ASPAC) and Jim Low (Americas)
– recently reviewed the major issues companies in each of their regions are
facing from a regulatory perspective in 2012.

Global Round Table:
Regulation hots up
Giles Williams: We’re going to talk in a GW: So turning to the ‘heat map’, the G20 CEO ISSUES
moment or two about the KPMG ‘Regulatory regulatory agenda is intended to:
Heat Map’ [Page 6/7] which captures the – create a new framework for banks, OTC
current impacts of regulation. But first I derivatives, compensation practices and
thought it would be helpful if we put it into a credit rating agencies; H
ow will regulatory change impact
broader context. During the global financial – address the too big to fail issue; ‘fill in the on our business model?
crisis, complete catastrophe was averted gaps’ in regulation and supervision of the
W
hat strategic changes will be
partly by luck and partly by concerted action by financial sector;
necessary for us to pursue maximum
governments and regulators. The G20 rapidly – tackle tax havens and non-cooperative
growth and profitability?
moved to the forefront of action to restore jurisdictions.
stability and began the process of building W
hat impact will regulatory change
a more resilient global financial services The ‘heat map’ locates the principal regulatory have on the most appropriate legal
structure. Markets and economies began to initiatives currently being implemented on entity structure for the group?
recover. However, I think all of us would agree a grid relating five key themes – financial
that the global recovery has weakened in stability, conduct, market infrastructure, tax H
ow should our operational
recent months and new trends are emerging. and finance and governance – to the three configuration evolve: onshore?
The regulatory debate is broad; with the primary industry segments of investment offshore? shared service centers?
systematic risk arguments, the role of capital management, banking and insurance. H
ow can risk best be controlled
and need for liquidity. This is in the context The color key reflects the main geographic and minimized in the firm in future?
of the wider political dimension focusing on regional impacts.
the role of financial services in the rest of the D
o we have an effective recovery
economy, the protection of consumers and the Simon Topping: What really comes across and resolution plan?
contentious issue of executive pay. to me from our analysis is that we’ve seen a A
re all our stakeholders signed up
significant change in the regulatory landscape to the same view of the future?
Jim Low: Right, and this is being felt, to a over recent months. One of the most obvious
greater or lesser extent, across all advanced points to note is that the three industry
countries. The specter of ‘double dip’ segments look really quite similar. There are
recessions is looming closer. In the USA, some differences of emphasis, for sure; but it
the economy remains weak, and consumer is now clear that the impact of new regulation
confidence continues to be weighed down will be widespread and comparatively
by a moribund housing market. In Europe, intolerant of special interests. In early 2011 it
as you know well, sovereign debt concerns was still possible to argue that hedge funds
are spreading, and the risk of default by one should be spared the most draconian new
or more members is calling the structure of requirements because they played no role
the eurozone into doubt. Across the globe, in creating the crisis; or that insurers operate
excessive debt – and concomitant deleveraging a fundamentally more stable business
– are dragging down economic performance model and require different treatment. Now,
already hit by increased commodity prices. however, there is little distinction; this is a real
And this is the key background to the G20’s change.
commitment, in November 2011, to work
towards a more stable and resilient international JL: I think that’s exactly right. The political
monetary system and to improve systemic agenda has ensured that the financial services
stability in the global economy. sector as a whole is going to share the pain.


Contacts (from left)
Giles Williams
Simon Topping
Jim Low

During the global financial
crisis, complete catastrophe
was averted partly by luck
and partly by concerted
action by governments
and regulators. The G20
rapidly moved to the
forefront of action to restore
stability and began the
process of building a more
resilient global financial
services structure.

But what we have now is a remarkably IMPLEMENTATION PROGRESS
complex and ambitious agenda.

GW: The G20 would no doubt argue that it is Reform Policy Key policy dates
deliberately comprehensive and consistent. ‘11 ‘12 ‘13 ‘14 ‘15 ‘16–’19
I have a quote from the final declaration from
the Cannes Summit in November 2011, J A S O N D
where they emphasized: Capital Basel III
“We are determined to fulfill the commitment
we made in Washington in November CRD3
2008 to ensure that all financial markets, CRD4
products and participants are regulated or
Liquidity Basel 3
subject to oversight as appropriate to their
circumstances in an internationally consistent Systemic risk FSB – GSIFIs
and non-discriminatory way.” EU Crisis mgt

ST: Well yes, but a more pragmatic UK ICB
assessment also raises a number of areas of Supervision ESAs
concern notably:
– scale and cost of the additional
the UK architecture
regulatory burden, all of which will be Governance EU green paper
borne, in the end, by financial services
Remuneration CRD3
companies and their customers
– scope for inefficiency, duplication,
the Customer EU access/lending
inconsistency and contradiction treatment
PRIPS
– the opportunities for regulatory arbitrage
– damage to global GDP which may
the SEPA
follow the imposition of a more costly, UK RDR
less profitable, less responsive financial
Traded OTC derivatives
services sector. markets
MiFID2
JL: Our three Regulatory Centers of Accounting/ EU green paper
Excellence are uniquely placed to compare disclosure
and contrast the impact in different CRA
geographic regions. Where are the agendas
most strongly correlated across the three Policy development Implementation In force
regions? Clearly, the most obvious area is
where firms are truly global in the first place:
regulation has to impose a consistent global
framework. But there is a deeper area where
the end-game itself implies convergence. For
example, the pressure for structural reform in
the banking sector may be stronger and more

© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no in Finance / 5
February 2012 / Frontiers client services. No

COLUMNS

REGULATORY HEATMAP European Union Global – G20 UK National United States

Investment management
Hot
AIFMD CRD 3/4 PRIPs
AIFMD UCITS AIFMD
UCITS
DFA RDR
DFA
DFA
Consumer
Protection

MiFD 2 EMIR
COREP
FTT

Cool

Financial Stability Conduct of Business Agenda Market Infrastructure Tax and Finance
and Investor Protection and Trading

Banking industry

Hot CRD 3/4 Short Selling
Credit
Default Swaps
Structural DFA Consumer
BASEL 2.5/3 Reform DFA Protection DFA
RDR
(RRPs)
Deposits MAD
Schemes Investor
Directive Compensation
Directive
MiFD 2 EMIR
COREP
MMR
ICB FTT

Cool


Insurance industry

Hot DFA

Solvency DFA DFA
Investor RDR
Living Wills Compensation Consumer
Schemes Protection

DMD
Pensions MiFD 2
Directive COREP
FTT

Cool



explicit in the UK and elsewhere in the EU. But
the consequences will inevitably be felt here
in the US, and in Asia, and will drive change So a key question is how
towards comparable ultimate goals. far, and in which directions,
Corporate Governance
ST: Indeed. For instance, recovery and
will these regional agendas
FATCA
resolution planning is now a significant influence each other in
regulatory agenda item in Australia, impacting future. How far will the
on companies which remained untouched by
the crisis. So to a significant extent a common US begin to reflect European
agenda is emerging, and common themes are concerns? Will the US
IFRS
extending across all geographical regions. But
although the G20 emphasizes the international
agenda be increasingly
and global nature of the framework it reflected in Europe?
believes is necessary, there are differences in
emphasis, and the balance between the five
themes is different.
Corporate Governance
GW: Some of the marked contrasts can be
and Decision Making
seen in the conduct agenda. This is not an
especially significant imperative in Asia. It is evidence seems to show that policymakers
of some relevance in the USA, but there it and regulators are acting in a responsible and
remains heavily colored by a strong caveat thoughtful manner, seeking to be proportionate
emptor principle: the customer needs to and achieve the broad objectives of restoring
recognize and assume an appropriate degree stability and increasing resilience without unduly
of risk, and so the emphasis is on supporting damaging competitiveness or economic value.
Corporate Governance information provision and understanding.
FATCA In Europe, however, it is a key theme of ST: Nevertheless, financial services will cost
the regulatory agenda: the cultural and more, and deliver lower returns, to the extent
policy mind-set is that the consumer needs that greater regulation imposes higher costs
protection, and cannot – or should not – be and lower profitability. The main problem arising
exposed to excessive risk. from this is there is little evidence as yet that
consumers accept the implications for the costs
IFRS ST: Nevertheless, despite such differences, and benefits they receive. This is going to make
I think we are seeing a kind of creeping the challenge for CEOs all the greater. But there
convergence in individual regional agendas. are clearly some key questions they need to be
Issues of governance run across all asking themselves.
three regions, although the strength of
implementation necessarily varies, from
Corporate Governance very prescriptive in the EU to – as yet –
and Decision Making more consensual in the Far East. There is MORE INFORMATION
convergence too in the way the objective Giles Williams
of strengthening financial stability is being Partner, Financial Services
extended into insurance through Solvency II; Regulatory Center of Excellence
and in the way that protection against systemic EMA Region
impacts is leading to resolution and recovery KPMG in the UK
planning for insurance companies. T: +44 20 7311 5354
E: giles.williams@kpmg.co.uk
Corporate Governance JL: So a key question is how far, and in
FATCA
which directions, will these regional agendas Simon Topping
influence each other in future. How far will Partner, Financial Services
the US begin to reflect European concerns? Regulatory Center of Excellence
Will the US agenda be increasingly reflected ASPAC Region
in Europe? KPMG in China
T: +852 2826 7283
IFRS GW: Yes, and one of the largest areas of E: simon.topping@kpmg.com
uncertainty, and one which interests me in
particular, is the extent to which the balance Jim Low
will change in future between returns Partner, Financial Services
to shareholders, customers, executives Regulatory Center of Excellence
and employees. There are constant, and Americas Region
Corporate Governance understandable, pressures from politicians KPMG in the US
and Decision Making and the public they represent to impose more T: +1 212 872 3205
drastic and punitive changes. So far, the limited E: jhlow@kpmg.com

© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no in Finance / 7
February 2012 / Frontiers client services. No

FEATURE

INVESTMENT MANAGEMENT

Brazil –
The new hotspot
in investment
management
By Marco Andre Almeida and Lino Junior

B
razil is now a major economic
power, one of the top-10
global economies by purchasing Unlike many other large
power parity1. It ranks ahead of economies, Brazil has a
its ‘BRIC’ counterparts Russia
and India (although it is smaller than China).
comparatively welcoming
The country enjoys a relatively stable macro- attitude to investment
economic environment, with consumer and funds and hedge funds –
investor confidence continuing to strengthen.
Inflation has been brought down since the recognizing the need to
early years of the new millennium, although it attract foreign investment
remains around 6.5 percent in 2011. However,
interest rates remain high – the short-term
to underpin continued
risk-free rate currently stands at 10.5 percent. economic and infrastructure
Unlike many other large economies, development.
Brazil has a comparatively welcoming
attitude to investment funds and hedge
funds – recognizing the need to attract
foreign investment to underpin continued
economic and infrastructure development.
The combination of high returns and a favorable
regulatory regime is driving a massive wave of
interest in investment in Brazil: it is indeed the daily updates of asset values and portfolio
new hotspot in investment management. details being posted on the internet.
Although the investment management
Investment management sector is large, it faces competition from
industry in Brazil certificates of deposit and savings accounts.
Brazil’s investment management industry The total investment portfolio is concentrated
is mature, well-managed and effectively- in Brazilian assets, with 60 percent of total
regulated. All funds – including those which investment in government bonds.
would be described as hedge funds – must
be registered with the Comissão de Valores Alternative investment industry in Brazil
Mobiliários (CVM) – Brazil’s equivalent of the There is increasing interest in the alternative
Securities and Exchange Commission. The investment market in Brazil. A number of
capital markets association, ANBIMA, operates different classes of investment vehicles exist.
a system of self-regulation which is generally These are all summarized in the panel on the
well-regarded. The market is transparent, with next page.

8©Frontiers in FinanceKPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
2012 KPMG International. / February 2012

FEATURE

ALTERNATIVE
INVESTMENT
VEHICLES

395bn
From top
High returns and a favorable
regulatory regime is making
Brazil the new hotspot in
investment management.

Infrastructure investment
in Brazil is pressing as Brazil
prepares to host the World
Cup in 2014 and the Olympics
in 2016.

The most attractive emerging as where income is taxed at less than 20
market for private equity percent and/or where there are restrictions
“As a country and an A recent survey by Coller Capital and the on disclosure of shareholder composition or
economy, we need private Emerging Markets Private Equity Association beneficial ownership).
equity and venture shows that Brazil has overtaken China as the
most attractive market for fund managers’ FIP investments are subject to certain restrictions:
capitalists to invest and to deal-making in the coming year2. Brazil offers – The portfolio company is usually a
help our entrepreneurs,” a number of fiscal incentives for inward Sociedade Anonima (S.A.), and is
investment in private equity funds (Fundos de required to have its financial statements
Maria Helena Santana, Chair Investimento em Participações – FIPs): audited by an independent auditor
of the Comissão de Valores registered with the Brazilian CVM. The
Mobiliários (CVM) – Brazil’s –
Income and capital gains received by
the funds are usually not subject to
FIP must have influence in strategic
decisions and its management.
SEC4 taxation in Brazil; – The investment must adhere to the existing
–
There is no withholding tax on disposal of foreign exchange regime for investments in
FIP quotas for non-residents as long as they Brazil’s capital market.
hold, together with related parties, less than – The financial tax (IOF) is levied on the inflow
40 percent of the shares of the FIP and are of foreign funds into the FIP at a 2 percent
not located in a low tax jurisdiction (defined rate (reduced to zero on 1 December 2011).

102012 KPMG International. KPMGFebruary is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
© / Frontiers in Finance / International 2012

Contacts (from left)
Marco Andre Almeida
Lino Junior

Private Equity Funds (FIPs) FIDCs (Credit Receivables
Investment Funds)
Size in September 2011: R$ 78.4 billion.
Taxation: 15 percent. Non-resident Size in September 2011: R$ 65.7 billion.
investors (other than those located in Taxation: generally from 15 percent to
‘low tax jurisdictions’) which hold up to 22.5 percent.
40 percent of the fund are exempted. Comments: At least 50 percent of
Comments: Minimum subscription of resources should be invested in credit
R$100,000. Invested companies must receivables. Derivatives are optional,
comply with certain corporate provided the objective is to hedge
governance rules. spot positions. Most funds value
credit receivables at cost plus accrued
Multi-Strategy Funds income, less allowance for losses as
determined by the Brazilian Central
Size September 2011: R$ 395 billion. Bank. New rules effective from 2011
Taxation: from 15 percent to 22.5 are consistent with IFRS approach.
percent (some exemptions).
Comments: Portfolios can include any

78.4bn financial investment, in accordance
with limits established in the by-
laws and CVM regulation. Overseas
investments are allowed in funds with
minimum subscription of R$1 million
up to 100 percent and in other funds up
to 20 percent.

Evolution: Brazilian Industry of Investment Funds (R$ Billion)

1,800
65.7bn 1,600
1,400
1,200
1,000
800
600
400
200
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Investing in the Brazilian financial market: Cup in 2014 and the Olympic Games in 2016,
Non-resident investors may invest in Brazil’s both of which require major investment in the MORE INFORMATION
financial and capital markets on level terms country’s infrastructure. It has been estimated Marco Andre Almeida
with resident investors. They need simply to that Rio de Janeiro alone needs $36 billion of Partner, Financial Services and National
hire a legal representative in Brazil (a financial investment to prepare for these two events3. Head of Private Equity
institution), and complete the necessary Brazil’s investment management industry is KPMG in Brazil
paperwork. However, getting the structure most definitely open for business. T: +55 213 515 9404
right and optimizing the balance sheet to take E: maalmeida@kpmg.com.br
advantage of the favorable tax opportunities 1. CIA World Factbook, February 2011
as well as to comply with domestic legislation 2. EMPEA/Coller Capital Emerging Markets Private Equity Survey – Lino Junior
and regulation is complex. Where purchases 18 April 2011 Partner, Financial Services
of local companies are concerned – as they 3. Financial Times, ‘Rio eyes ‘Olympic bonds’ to fund 2016 games’, and Hedge Funds
2 February 2011
have been with sovereign wealth fund 4. As quoted in The Economist, 17 February 2011
KPMG in Brazil
investments – the necessary due diligence T: +55 213 515 9441
can be time-consuming. E: lmjunior@kpmg.com.br
Having said this, the requirement in Brazil
for infrastructure investment, especially, is
pressing, particularly in the transport sector.
In addition, Brazil is to host the football World

member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate2012 any member firm. All rights reserved.
February or bind / Frontiers in Finance / 11

FEATURE

CAPITAL MARKETS

A reactive approach to a rogue trading can have dire
consequences for a firm. The right actions and approach
can defend against this threat.

Rogue Trading:
Controlling the risk
By Bill Michael

R
ogue traders have always existed companies need to understand if they are to
in one form or another. The
combination of breach of faith,
NOTORIOUS institute effective controls.
The first key point to note is that no company
betrayal of trust and deception LOSSES is immune. Wherever large sums of money
is common to most areas of flow through large institutions, there will always
financial crime. What tends to mark out the be the potential for rogue trading to emerge.
contemporary rogue trader is a particular set Constant vigilance and defense in depth are
of circumstances and characteristics: essential. Furthermore, it is usually not the
most high-profile, complex or apparently risky
– he individual involved is normally not
t
motivated by personal greed, at least directly
– deception starts small but spirals out
his
of control

$2.3bn
Kweku Adoboli
areas of activity which are most susceptible.
The majority of rogue trading occurs in
comparatively humdrum or presumed safe
parts of the business, out of the spotlight.
– he sums involved can reach astronomical
t UBS, 2011 Problems can start small but rapidly escalate to
proportions. threaten the whole firm.
There are also a number of institutional and
It is unsurprising that the actions of such individual features which contribute to rogue
individuals hit the headlines. Among the
most notorious instances in recent years:

– weku Adoboli is alleged to have caused UBS
K
€4.9bn
Jérôme Kerviel
trading. These are the subject of increasing
debate in the industry. It is perhaps a cliché
to point to the excessive risk-taking mentality
and aggressiveness of mainly-young, mainly-
to lose $2.3 billion trading on market futures Société Générale, 2008 male traders. But there is no doubt that there
in 2011. is a tendency for companies to hire as traders
–
Jérôme Kerviel lost Société Générale €4.9 people who tend to be more prone to such
billion over three years to 2008, again as a activity. When traders are speculating with

$6.5bn
result of trading stock market futures. other peoples’ money, the need for external
– rian Hunter lost $6.5 billion for
B controls is clear.
Amaranth Advisors in 2006, trading on Secondly, a corporate culture which
natural gas futures. Brian Hunter encourages (acceptable) risk-taking can easily
– erhaps most famously, Nick Leeson brought
P Amaranth Advisors, 2006 become one where excessive risk-taking is
about a loss of £827 million, and caused the tolerated, or where those involved become
collapse of Barings Bank after 233 years blind to it. When trades which push the bounds
of existence, through his trading on the of what is permissible come off, and the firm

£827m
Nikkei Index. makes a large profit, there is an obvious danger
that improper behavior is reinforced. Many
Such stories receive sensational media rogue traders have subsequently claimed that
coverage, and it is always dramatic to depict Nick Leeson their activities were condoned because their
a single individual being responsible for such Barings Bank, 1994 superiors also enjoyed the rewards which came
catastrophic consequences. However, the real with success.
reasons behind, and causes of, rogue trading It is rarely the case that a trader starts out
are more complex. It is these features which by intending to commit fraud. Rarely also is the


Contacts
Bill Michael

of repeatedly doubling up in a desperate of suspense accounts, fictitious trades which
Motivating factors: attempt to recover the situation, all the while lack counter-party recognition, cancelled
the environment engaging in increasingly elaborate deceptions trades, excessive gross versus net exposure
What are the typical factors that to disguise his true position. and so on. Acceptable profiles for all of these
create the environment for rogue It is much easier to hide transgressions characteristics can be developed, with events
when a large volume of transactions is taking outside the established parameters triggering
trading activity? place against a background of fragmented an alarm.
IT systems and complex processes. Where There are also a range of non-technical
middle- and back-office responsibility is factors which need to form part of an
Aggressive culture compartmentalized, no-one may be in a effective control framework. These range
of PL and revenue performance rather position to see the whole picture. Complex from mandatory training to appropriately-
than wider risk and control based metrics trades can be very difficult to value accurately disciplined controls on access to systems
by anyone other than the front-office and records. It has been well-publicized in
Remuneration expert who is carrying them out. If senior a number of cases that rogue traders have
linked to short term performance management or supervisors don’t fully tended to work odd hours, and have been
understand the nature of products being reluctant to take vacations in case their
Repeated control breaches traded or their inherent risk profile, it is much positions were exposed. Profiles for these
tolerated by senior management easier for the rogue trader to disguise the true characteristics should also be established,
nature of his position. and divergence flagged up. Correlation
Insufficient challenge It follows from these features that an between suspicious activities in a number
to (by control functions) and within effective defense needs two mutually- of areas can be especially valuable.
(by supervisors) front office reinforcing strands: adequate and appropriate Systems and controls are typically
controls and the right tone being set from the introduced and/or strengthened in the wake
High volumes of trades top. It has been well-said that there are bold of a rogue trading disaster – if the firm has
supported by fragmented IT systems traders and old traders, but there are very managed to survive it. But the risk of adopting
and complex processing environment few old, bold traders. Senior management a reactive strategy is clear. By contrast, firms
need to instill a strong culture of respect for should be adopting a strategy of continual
Poor understanding controls – which still promote acceptable review, stress testing, monitoring and
of complex products and trading risk-taking – while explicitly prohibiting the development, to ensure that their defense is
activities by senior management occasional tolerance of breaches. Turning a as strong as possible.
blind eye from time to time to an unauthorized
gamble which pays off risks undermining the
whole control framework.
motivation personal gain, except in the sense In such a culture, it is then much easier to
that successful trading may bring kudos and institute effective systems and controls and
a bigger bonus. Rather, a trade at the limit of to make sure they are respected. Most cover- MORE INFORMATION
acceptability may go wrong. Instead of closing up strategies are comparatively simple. The Bill Michael
out the position and triggering a loss, the trader most obvious course, if closing out a trade is UK Head of Financial Services
may try to recoup the loss the next day. All goes going to crystallize a loss, is to avoid booking KPMG in the UK
well until a loss cannot be recovered. Then it in the first place. So systems need to look T: +44 (0) 207 311 5292
the trader embarks on the disastrous course for long settlement dates, late bookings, use E: bill.michael@kpmg.co.uk

© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG2012 / Frontiersno client services. 13
February International provides in Finance / No

FEATURE
HEADING HERE

BANKING

Customer Remediation

Getting it
right once
you’ve got
it wrong
By Scott Cohen and Dan Thomas,
with contributions from Edwige Sacco

W
arren Buffett famously likes to say that, ‘Only
when the tide goes out do you discover who’s
been swimming naked’. The straitened economic
environment following the financial crisis has
contributed to the exposure of frauds such as the
‘Ponzi’ scheme run by Bernard Madoff in the US, or various buy-
to-let property frauds in the UK. Similarly, when asset values suffer
serious reverses and liquidity dries up, investors and customers begin
scrutinizing much more closely the soundness of investments they
have made or been sold. Some of the malpractice which has emerged
in the last few years on the part of the financial services industry has
been profound and far-reaching.
In the US, the foreclosure crisis which emerged in 2010 remains
unresolved, despite tremendous regulatory scrutiny and notable
industry reform. It has revealed a widespread epidemic of foreclosures
that were inappropriately initiated and inappropriately handled.
Many have involved a lack of understanding of the legal/regulatory
requirements and often been coupled with poor or in some cases
fraudulent processes:

– ortgagees have foreclosed on homes with no outstanding debt,
M
employed ‘robo-signing’ methods to expedite thousands of false
affidavits and foreclosed on the homes of servicemen and women
on active duty in express violation of federal law.
– here have been significant failures of the controls intended to
T
safeguard the positions of both the borrower and the lender.
– nsufficient attention has been paid to borrowers and to the
I
overall borrower experience.
– nstitutions placed excessive reliance on third parties –
I
especially attorneys – to do the right thing. »


Frontiers in finance magazine - February 2012

Frontiers in finance magazine - February 2012

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