Professional Documents
Culture Documents
Introduction
o $691 million lost in the foreign exchange market o $1 billion profit at AIB for 2001 reduced to $426 million o 5 years of fraud and undiscovered losses o 7 years in prison with $1 million fine o How did this happen?
Agenda
o Foreign Exchange Concepts o Trading Strategies o The Losses and the Cover-up o Near Misses o Lessons Learned o Summary
o Future Standardized Forward Contract amounts and exercise dates are standard March, June, September, December
Currency Options
o Gives the holder the right, but not the obligation, either to buy from the option writer, or to sell to the option writer, a stated quantity of one currency in exchange for another o Strike price is a fixed rate of exchange o On a particular date (European) or up to a particular date (American) o Option holder (buyer) pays a premium to the option writer (seller) when the option is written o An option gives the holder the choice to exercise it. o Calls and Puts are available.
Background
o Allied Irish Bank acquired First National Bank of Maryland (First Maryland) in 1989 o Treasury Department run by David Cronin o Front Office Trading and investment o Middle Office Asset and Liability Management and Risk Control o Back Office operations and verification of Front Office trading o Small foreign exchange operation with trading to hedge for clients at Allfirst
The Cover-Up
o Bogus options o 'Fake docs' o Prime Brokerage Accounts o Value At Risk o Options for Sale
Bogus Transactions
o Fictitious trades entered in the banks accounting systems appeared to hedge the directional trades. o Bogus trades were entered in pairs that offset each other o Options looked like they had identical premiums in the same currency
Pay-OFF DIAGRAM
Fake Docs
o Every trade at the bank was required to be independently confirmed by the Treasury back office. o Rusnak used his PC to create false trade confirmation documentation. He called the file on his computer "fake docs". o Mail Box Etc. to fake Fax confirmation o Rusnak bullied the back office into not confirming Asian trades that netted to zero.
Value at Risk
o Main method used by banks to monitor traders activities o Largest loss the bank anticipates given adverse trading conditions o Calculated using the 'Monte Carlo' simulation technique to generate 1000 hypothetical rate fluctuations and the resulting profit or loss o The Value at Risk (VaR) is the 10th worst outcome for the portfolio o Rusnak's limit was $1.5 million
Citibank's Deal
o $125 million in cash for a strike rate of 77.37 yen to the dollar in return for an option that would expire in a year and a day o Yen at the time was 116 to a dollar o Dollar would have to fall 35% or more for the option not to be exercised o Option was effectively a high interest loan
Near Misses
o 1999 - Risk Assessment auditor questions Rusnak's over limits o March, 2000 - Citibank questions Allfirst's ability to settle a $1 billion prime account o March 2000 - Rusnak gets Travel Bloomberg software to trade at home and on vacations despite this being a violation of US law.
Lessons Learned
o Some of the lessons are strikingly similar to those of other rogue trader cases, such as Barings: o Lack of clear reporting lines, inadequate supervision of employees and failure to control fully the business that an overseas office was engaged in.
Lessons Learned
o Proprietary trading is a high-risk activity and it is not just a question of market risk. A relatively small outfit without access to the information, expertise and economies of scale of much larger financial institutions may find it difficult to manage and control a proprietary trading business effectively. The potential operational risks may outweigh the potential market returns, perhaps greatly.
Lessons Learned
o The relationship between parent company and overseas units needs to be clear From the o Ludwig Report: We think it is enormously important that there is unambiguous accountability. In some areas, it was not clear who was accountable to whom, and the reporting lines within Allfirst and between Allfirst and AIB were blurred.
Summary
o Rusnak lost money and covered the loss in hopes he could win it back. o Technology lapses in the bank were optimized to hide losses o Regular internal audits did not take place o Back Office monitoring of trades was ineffectual o Politics between AIB and Allfirst interfered with monitoring Rusnaks activities
Resources
o Report to the Borad of Directors of Allied Irish Banks, P.L.C., Allfist Financial INC.,and Allfirst Bank Concerning Currency Trading Losses Submitted by Promontory Financial Group and Wachtell, Lipton, Rosen & Katz March 12, 2002 o Panic at the Bank by Siobhan Creaton and Conor OClery o www.aib.ie o Foreign Exchange Markets Brian Coyle o Currency Options Brian Coyle o Trading in Currency Options William Sutton o New York Times o Financial Times www.ft.com