Banks must have guide on derivatives trading
Having watched Daiwa and Sumitomo Corp implode, no regulator will want to preside over a similar trading disaster.
The Hong Kong Monetary Authority (HKMA) has investigated the derivative operations of 20 banks over the past 18 months and found some worrying trends in their risk management.
No 'life-threatening' cases were uncovered, but it seems Asian banks support fertile territory in which a rogue trader can blossom.
The HKMA swat team spent weeks at a time assessing banks' internal controls that regulate traders, salesmen, managers and settlement staff.
Its monitoring was limited to management controls rather than a comprehensive audit of market and credit risk exposure.
Results showed that Asian banks, including Japanese institutions, typically ran derivative desks with no written operations manual governing policy or procedure.
Asian office culture tends to eschew a legalistic approach to internal controls and compliance. Informal and often unspoken rules dictate the way many banks manage their risk, according to the HKMA.
This is a cultural luxury that cannot be afforded as the events of the past year have proved.
Practitioners have sustained a cottage industry in bad metaphors insisting derivatives do not destroy banks, rather people do.
The failures at Barings involved the cardinal sin of not separating back and front office. HKMA inspectors found cases of banks running adequate controls, given their existing manpower and operations.
But the lack of written command and control procedures opened the possibility for abuse should significant personnel changes take place without an adequate handover.
Derivatives are here to stay so long as financial markets remain volatile and risk needs to be hedged.
Western banks were the first into the market and have developed the most sophisticated systems to control their use. No system is fail-proof, but this is one aspect of business that is not open to the relativist debates of Asian versus Western.
The HKMA is the most hands-off regulator in Asia, relying on management discipline as the quid pro quo for non-intervention. Asian institutions trading derivatives should write their operation manuals now, rather than after another disaster.