Operational Risk Management - 2013 - Girling - Appendix Answers To Review Questions

APPENDIX
Answers to Review Questions
CHAPTER 1
1. c
2. a
CHAPTER 2
1. a
2. d
CHAPTER 3
1. c
2. b
CHAPTER 4
1. b
2. b
CHAPTER 5
1. b
CHAPTER 6
1. c
Operational Risk Management: A Complete Guide to a 309

Successful Operational Risk Framework, Philippa Girling.
© 2013 Philippa Girling. Published 2013 by John Wiley & Sons, Inc.
10.1002/9781118755754.app1, Downloaded from https://onlinelibrary.wiley.com/doi/10.1002/9781118755754.app1, Wiley Online Library on [18/03/2024]. See the Terms and Conditions (https://onlinelibrary.wiley.com/terms-and-conditions) on Wiley Online Library for rules of use; OA articles are governed by the applicable Creative Commons License
OPERATIONAL RISK MANAGEMENT
CHAPTER 10
CHAPTER 11
CHAPTER 12
CHAPTER 13
CHAPTER 14
CHAPTER 7
CHAPTER 8
CHAPTER 9
b
1. d
1. b
1. a
2. a
1. a
1. a
c
1. c
1. c
310
1.
2.
3.
4.
Answers to Review Questions 311
CHAPTER 15
1. d
CHAPTER 16
1. c
CHAPTER 17
1. b
CHAPTER 18
Case 1
ORX classified the event as outlined in Figure A.1:
FIGURE A.1 ORX Classification of Knight Capital Event
1. In the ORX standards, EL0601—Technology and infrastructure failure

is a risk that relates to losses arising from disruption of business or sys-
tem failures. This is equivalent to the Basel II risk category of Business
Disruption and System Failure.
2. ORX states the main cause as CS0503—Software—Inadequate
Maintenance.
3. ORX classify the business line as BL0201—Equities, which is a subset
of their Trading and Sales business line category.
312 OPERATIONAL RISK MANAGEMENT
Case 2
FIRST classified the Standard Chartered event as shown in Figure A.2:
FIGURE A.2 FIRST Classification of Standard Chartered Event
4. FIRST classified this as an Execution, Delivery, and Process Manage-

ment event.
5/6. FIRST provided helpful details on the event and the lessons learned. The
full text of the event in FIRST is significantly longer than the excerpt
provided.
Case 3
7. FIRST provides the following suggested lessons learned, many are
repeats of exactly the same control failings as were identified in the
Société Générale case.
Lessons Learned
The Wall Street Journal on September 16, 2011 said that banks
seeking to detect unauthorized trading should supplement their
routine electronic surveillance with “an older method of detection:
looking out for suspicious behavior.” Echoing some findings of
the Societe Generale investigation, the WSJ cited several red flags:
“traders not taking vacations; traders having a lot of cancelled or
amended trades; traders working out of business hours or logging
fewer hours on recorded lines; and traders whose trades are ques-
tioned by counterparties or exchanges.” The size of the loss in this
case certainly poses a reputational risk to UBS. In the words of a
Financial Times (September 15, 2011) report, “Hard questions need

to be asked about UBS’ internal risk controls. It’s hard to believe
the Swiss bank’s view that it cannot identify the area in which the
rogue trades were made, or when more information might become
available—everything has an electronic audit trail.”
The loss amount ($2.3 billion) is the largest rogue trading loss
ever by a Swiss bank and the third‐largest unauthorized trading
loss on record, exceeded only by the January 2008 Societe Generale
loss of $6.8 billion (Event #7945) and the 1996 Sumitomo Corpo-
ration loss of $2.8 billion (Event #1699). These and other cases can
be found using the Unauthorized Trading keyword.
Nor is this the first time that the London offices of UBS have
suffered from unauthorized trading. In November 2009, the FSA
fined UBS GBP 8 million ($13.3 million)—one of the FSA’s biggest
fines ever—for weak controls that allowed staff to make as many as
50 unauthorized trades a day on at least 39 client accounts and then
conceal the losses. (see Event #9481)
The Wall Street Journal reported on September 22, 2011, that
the FSA was looking into several possible rogue trading cases at
other institutions in London. “At least three of those cases involve
traders who previously had worked in the bank’s ‘back‐offices’
where employees enter and confirm trades, handle accounting issues
and transmit payments,” the paper said. After the Societe Generale
fraud, some banks reportedly began asking supervisors of trad-
ers who come from a “back‐office” background to enhance their
supervision. Since the FSA does not have sufficient staff to moni-
tor trades at large banks however, it is incumbent on banks to be
aware of risky trades before large losses are found to have occurred.
Traders exceeding their risk limits can (at least in theory) return
profits, so banks should pay attention to unexpectedly large profits
before they are surprised by unexpectedly large losses.
One of the key questions to be answered by any investigation
is how such a large unauthorized trading loss on the “Delta One”
desk went undetected, especially after the highly‐publicized Societe
Generale fraud. Since it appears that Mr. Adoboli’s losses were in
market index futures (as was the case with trades executed by
Jerome Kerviel) it is as yet unclear why his fictitious hedging posi-
tions went unchecked. At the very least banks should require confir-
mations of ETF trades by counterparties.
At least one online analyst, Paul Amery, argues that lax op-
erational settlement procedures for bank‐traded ETFs could prove
to be a major factor. Firstly, in London the late settlement of ETF
314 OPERATIONAL RISK MANAGEMENT
transactions is not unusual and is not subject to major sanctions.

Secondly, many counterparties do not request trade confirmations,
especially for OTC transactions. Mr. Amery concludes: “Taken to-
gether, these two loopholes may have enabled the creation of fake
transactions in UBS’s systems. Even if this was the immediate cause
of the fraud, the bank’s risk controllers seem to have missed other
warning signs. High gross trading positions, even if the trader
reported his position as hedged, plus what were presumably signifi-
cant cash outflows in margin as the result of losing futures posi-
tions, might together have been expected to flag that something was
wrong.”
The Financial Times reporter Gillian Tett noted that trading
in ETFs requires yet more attention from regulators, since sales of
ETFs—which have been very profitable for banks—could pose con-
flict‐of‐interest problems if banks were acting as counterparties in
the same funds they sold to customers.
A few weeks before it disclosed the loss, UBS had announced a
plan for 3,500 layoffs—a 5 percent cut in its global work force—half
of them in the investment banking arm, in order to meet tougher
economic conditions. Press reports said that the loss would also
lead to calls from investors and legislators for Swiss banks to re-
duce their investment banking activities and focus more on private
banking and fund management. Regulators could ask for even more
stringent capital requirements for investment banking activities, or
seek to protect client business from risky proprietary trading.
The Swiss parliament was discussing measures to improve the
safety of the biggest Swiss banks (UBS and Credit Suisse) even as
the event was disclosed. The “too big‐ to‐fail” banks earlier got
taxpayer bailouts after losing large amounts investing in mortgage‐
backed securities from 2006 to 2008. A representative of the Swiss
People’s Party (SPP) told Bloomberg News: “There can’t be another
state bailout. It can’t be up to the state and taxpayers to rescue large
banks that are involved in risky business.” Another SPP member
found yet another lesson: “It shows that investment banking is a
high‐risk field and it’s important that we clearly separate systemi-
cally important functions from the rest of the banking business.”
Such concerns have also been echoed elsewhere.
The proposal to “ring‐fence” bank activities on their custom-
ers’ behalf from risky bets in proprietary trading was a feature
both of the Volcker rule (enacted as part of the Dodd Frank Act)
in the United States, as well as the recent Vickers Report (available
here) into banking in the United Kingdom. Proponents of stricter
banking regulation in these and other countries will likely to point

to the UBS case to bolster their argument. As Martin Wolf, a col-
umnist for the Financial Times wrote: “Thank you UBS . . . I could
not have asked for a better illustration of the unregulatable risks to
which investment banks are exposed.”
In what may be an emerging trend, the Swiss regulator FINMA
noted in its summary report that outsourcing of control functions
to India was a contributing factor in UBS’ failure to detect unau-
thorized trading. Such outsourcing has also been mentioned in an-
other high‐profile case. In August 2012, the New York Department
of Financial Services accused Standard Chartered of involvement
in laundering financial transactions (11885). The regulator said the
bank’s compliance function had been moved to Chennai. The New
York regulator cited “no evidence of any oversight or communica-
tion between the Chennai and the New York offices” with regard
to Standard Chartered’s compliance with regulations issued by the
Office of Foreign Assets Control (OFAC).

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APPENDIX

Answers to Review Questions

Operational Risk Management: A Complete Guide to a 309

FIGURE A.1 ORX Classification of Knight Capital Event

1. In the ORX standards, EL0601—Technology and infrastructure failure

FIGURE A.2 FIRST Classification of Standard Chartered Event

4. FIRST classified this as an Execution, Delivery, and Process Manage-

Financial Times (September 15, 2011) report, “Hard questions need

transactions is not unusual and is not subject to major sanctions.

banking regulation in these and other countries will likely to point

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