ETF Trends
ETF Trends

A UBS AG (NYSE: UBS) “rogue” trader exploited  a major loophole in trading exchange traded funds (ETFs) that caused the Swiss bank to incur huge losses on fake positions.

In Europe, a loophole may have allowed one UBS trader to write $2.3 billion in false trades as banks on the the other side of the trade weren’t required to confirm the transaction, reports Andrew Peaple for The Wall Street Journal.

UBS stated that the lone trader undertook “unauthorized speculative trading in various S&P 500, DAX and EuroStoxx index futures over the last three months” through fictitious hedging positions in the bank’s internal systems, reports Emma Thomasson for Reuters.

Over 70% of ETF trades are done “over-the-counter” in Europe, and European banks are not required to confirm ETF Trades done in this manner. Because market participants don’t need to report these trades to a regulator, European regulators do not know who holds what in the ETF market.

Regulators, though, are thinking about a new Markets in Financial Instruments Directive, or MiFid 2, which will require confirmation procedures and reporting requirements on over-the-counter trades; however, the new regulation won’t be implemented until 2013.

Trades conducted on “Delta One” desks are driven by banks wagering their capital to make a profit in proprietary, or “prop,” trading, report Luke Jeffs and Douwe Miedema for Reuters.

The U.S. has approved the “Volcker Rule,” which will restrict prop trading. Goldman Sachs, Deutsche Bank, Morgan Stanley and JP Morgan have already diminished their stand-alone prop desks in anticipation.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.