Rogue trade throws spotlight on ETFs

The spotlight has been thrown on exchange traded funds (ETFs) again by last week’s admission from UBS that a rogue trader had lost the company £1.3 billion.

The bank was forced to report to the market that unauthorised trading in its investment bank division had caused losses in the region of $2 billion, which could lead to the firm reporting a loss for the third quarter.

However, it was quick to state that no clients had lost money because of the rogue trade. (article continues below)

Kweku Adoboli, a trader with UBS, was arrested after the firm called City of London police alleging fraud. Reports have suggested Adoboli was involved in the trading of derivative-backed tracking instruments such as ETFs, although full details have yet to emerge.

Terry Smith, the founder of Fundsmith and an outspoken critic of ETFs, says the loss highlights the risks of the index-tracking funds.

The fund manager says there are numerous problems with “synthetic” ETFs using derivatives to track the performance of indices or assets. He suggests that the possibility of mis-selling and the risks being incurred in running, constructing, trading and holding ETFs are not being understood.

News of the rogue trade promp­ted the rating agencies Moody’s, Standard & Poor’s and Fitch to put the Swiss bank under review for a possible downgrade as they continue to assess the impact of the loss.

The agencies have raised questions over risk management at the bank and the efficiency of controls in its investment banking division. They are also considering what the reputational impact of the loss on the bank could be to its private clients and wealth management divisions.

In America, Finkelstein Thompson, a law firm, said it would investigate potential claims on behalf of UBS shareholders.

The amount lost was not as large as Jerome Kerviel’s rogue trade of £3.5 billion at Société Générale in 2008, but is bigger than the loss by Nick Leeson that brought down Barings Bank in the 1990s.

The loss will trigger fresh demands for the ring-fencing of banking activities, particularly after the publication of the Vickers report last week.