Trading Technology

04:39 PM
Connect Directly
Facebook
Google+
Twitter
RSS
E-Mail
50%
50%

Complex Trading Infrastructure Lends Itself to Costly Booking Errors

More than fraud, fat-fingered booking errors are resulting in big losses for traders.

Between 2011-2012 it is estimated 9.1 billion euros in trading losses were incurred through operational problems. These losses were not due to bad positions, nor because of fraud, but because during execution and the settlement process something went wrong.

If JPMorgan trades with Goldman Sachs, that trade will go through some kind of external confirmation venue, and both sides will view the others transaction. But when the trades are internal, banks often choose to lower their costs by adopting an internal solution.

These systems are typically excel-dominated in the middle or back office and lacking the infrastructure to detect errors and fraudulent behavior. Worse, internal unmatched trades can go unnoticed for a long time, polluting the downstream systems. The longer a problem is out there, the more expensive it is to correct. The more systems it goes into, the more changes needed to be made.

"This is big," says Neil Vernon, development director at Gresham Computing, a reconciliation and transaction control software provider. "It has nothing to do with fraud, it's simply that banks have complicated infrastructures and things can go wrong in that infrastructure." One of the analogies he likes to use is FedEx. For $10, they will ship a package from NY to London and they will tell you where the package is along the way. "For a trade, I can't get those updates. It's a spaghetti of complex infrastructure. The vast majority of time they pop out the other side with no problems, but a small percentage fail from system 1 to system 2, and we can't get that fixed in real time." From his viewpoint nothing really changed since the study in terms of improving control environments.

In the case of the London Whale, the controls were in spreadsheets, open to manipulation, and the trader took advantage of the T+3 oversight of the unmatched trades.

Need to Automate

The primary response to economic and regulatory pressure in this area is to remove manual middle-office spreadsheet based controls, refereed to as user development applications (UDAs).

"You have to automate as much of your control environment as possible," says Vernon. Solutions like Gresham' Clareti Transaction Control (CTC), a reconciliation software that allow for the same certainty with internal trades as external trades, have seen strong and growing interest from firms looking to replace excel infrastructure.

The software can identify within seconds if a trader booked the other side of a trade, preventing the escalation of transactional loss events.

Since its launch in the beginning of the year CTC has detected problems every day, but not one of them has been due to fraud. All have been attributed to booking errors, minor fat-finger problems -- all innocent trading mistakes that ultimately would have given rise to problems noticed days later.

Risk In Non Standard Products

Some products are highly standardized, and the way JP Morgan processes the messages would work the same as Goldman or Societe Generale. The pure number of transactions lend itself to errors in this area but the real risk, Vernon explains, is in the markets for non-standard products like OTC derivatives.

"In those worlds there is a lack of standards and best practices, and the messages and formats you receive tend to be more complicated and less standard. So we have a high volume of data, and you have to have to deal with large variety of data formats." Legacy UDAs will continue to struggle with these lack of standardizations, limiting a firm's ability to safely enter new markets. Becca Lipman is Senior Editor for Wall Street & Technology. She writes in-depth news articles with a focus on big data and compliance in the capital markets. She regularly meets with information technology leaders and innovators and writes about cloud computing, datacenters, ... View Full Bio

Comment  | 
Print  | 
More Insights
Comments
Newest First  |  Oldest First  |  Threaded View
Nathan Golia
50%
50%
Nathan Golia,
User Rank: Author
11/27/2013 | 8:47:01 PM
re: Complex Trading Infrastructure Lends Itself to Costly Booking Errors
More complexity always leads to more opportunities for error Gă÷ that's just how it works. But with so much money at stake you have to think that any errors will be corrected quickly and easily.
Becca L
50%
50%
Becca L,
User Rank: Author
11/25/2013 | 10:23:39 PM
re: Complex Trading Infrastructure Lends Itself to Costly Booking Errors
You have a point. I'm not too familiar with these alternative asset classes, but he did say the CTC software is capable of matching these complex products and I assume similar software can or will do the same. Companies that do adopt ahead of regulation will surely benefit.

I suppose when a company switches over from excel with one asset class it would follow suit with the others. I don't see why they wouldn't want to, given the "fat fingered" savings - let alone the compliance benefits.
IvySchmerken
50%
50%
IvySchmerken,
User Rank: Author
11/25/2013 | 7:10:52 PM
re: Complex Trading Infrastructure Lends Itself to Costly Booking Errors
Talking about spaghetti infrastructure, derivatives and off-balance sheet hedges have been an opaque area.

I'm sure this is an area that has been ripe for hiding losses. Gresham mentions there are no best practices in derivatives. I suspect this is changing under Dodd Frank with firms moving positions off spreadsheets.
IvySchmerken
50%
50%
IvySchmerken,
User Rank: Author
11/25/2013 | 7:03:08 PM
re: Complex Trading Infrastructure Lends Itself to Costly Booking Errors
To answer your question, this brings transparency to errors and deliberate fraudulent trades that would not otherwise be detected and hidden. Conversely, Madoff had a scheme to elude detection and faked his systems. Well, he had his accountant involved in the Ponzi Scheme. Those determined to commit fraud are difficult to stop.
IvySchmerken
50%
50%
IvySchmerken,
User Rank: Author
11/25/2013 | 7:00:31 PM
re: Complex Trading Infrastructure Lends Itself to Costly Booking Errors
It's kind of a Big Brother type of application so it makes sense that fraudsters would be careful and abstain. Even though automated reconciliation is always on, it has to be watched and paid attention to. Did Gresham say how a firm keeps tabs on the output of such a system?
Becca L
50%
50%
Becca L,
User Rank: Author
11/25/2013 | 5:01:30 PM
re: Complex Trading Infrastructure Lends Itself to Costly Booking Errors
It may be worth mentioning that, according to Vernon, the absence of fraud detected by Gresham's software is because a trader would be mad to think they could get away with tricks when these controls are in place. I wonder if that will just mean we can look forward to new fraud techniques. When one door closes...
Becca L
50%
50%
Becca L,
User Rank: Author
11/25/2013 | 5:00:39 PM
re: Complex Trading Infrastructure Lends Itself to Costly Booking Errors
Absolutely. With several spreadsheets open to several fat-finger users, there are so many places an error can occur and unmatched trades can hide. The lack of oversight gives quite a bit of power to the traders who know where to look in the spaghetti infrastructure, and can pinpoint areas for manipulation.
IvySchmerken
50%
50%
IvySchmerken,
User Rank: Author
11/25/2013 | 2:55:59 PM
re: Complex Trading Infrastructure Lends Itself to Costly Booking Errors
It's sounds like financial firms still have a lot of work to do with eliminating internal usage of Excel-based systems and complex webs of back-end systems. As a simple fat finger or error makes its way through a complex spaghetti like internal structure, hidden losses can mount. As you noted, JPM's London Whale traders were able to use spreadsheets and hide their losses by taking full advantage of U.S. T+3. If the firm had a better reconciliation/internal controls system, operations staff would have an automated audit trail of everything going on.
Register for Wall Street & Technology Newsletters
White Papers
Current Issue
Wall Street & Technology - July 2014
In addition to regular audits, the SEC will start to scrutinize the cyber-security preparedness of market participants.
Video
Exclusive: Inside the GETCO Execution Services Trading Floor
Exclusive: Inside the GETCO Execution Services Trading Floor
Advanced Trading takes you on an exclusive tour of the New York trading floor of GETCO Execution Services, the solutions arm of GETCO.