Safety of Exchange Traded Funds questioned after UBS rogue trader losses

16th September 2011

Here City veteran Terry Smith of Tullet Prebon uses his Terry Smith blog to go on the offensive. ETFs are a particular bugbear of Smith's but he is convinced the products, especially the complicated versions are being missold to the retail market.

He writes: "The losses of $2bn incurred by an allegedly rogue trader on the Delta One desk at UBS have again raised the subject of the (lack of) risk controls by banks dealing in opaque instruments, the need to separate investment and retail banking and the risks inherent in ETFs."

And at the end of a long tirade, he concludes: "Although ETFs are billed as low cost they are also the most profitable asset management product for a number of providers. How can this apparent contradiction be so? The answer is that the charge for managing the ETF is only one part of the cost. There are also the hidden costs in the synthetic and derivative trades which the provider undertakes for the ETF. There is a certainty that ETFs are being mis-sold to the retail market and that the risks that are being incurred in running, constructing, trading and holding them are not sufficiently understood. After the UBS incident, I think this should be regarded as indisputable."

And this report from May, may be grist to Smith's mill.

At the time, Efinancial News reported the UBS was the number one ETF provider and sales of $4.2bn in the first four months of the year.

Citywire's Charlie Parker says there are many questions to be answered. He writes: "I confess I need to much better understand the processes that take place and the extent to which it puts ETF assets in jeopardy (or not as the case may be). I am not throwing stones at providers, but surely I am not the only one who has over the past week been surprised to learn that banks – and in particular UBS – have deliberately and publicly moved to allow greater risk taking in the 'flow trading' activities which underpin ETF investing? Is it not enough for them that the ETF industry is itself booming? Why do they have to search for ever cleverer ways to cream a little bit more margin off?"

However some ETF providers have hit back saying retail money is safe.

But as yet, they are not prepared to have the quotes attributed, which doesn't come across well. Trade website IFAonline quotes a ‘London-based ETF head' saying: "Because of the Ucits regulations the losses will never happen at the fund level", adding that it will be the bank that takes the losses. The main thing is there has been no impact on UBS ETFs or any other ETF out there," he says. "People have put two and two together and come to the wrong conclusion."

Others like Smith are also in ‘I told you so mood'. Unfortunately, that sees Zero Hedge's Tyler Durden fearing further blow ups.

He notes that only yesterday he was saying that problems at another fund, Goldman Global Alpha suggested that issues elsewhere were still to be revealed.

"Sure enough not even 6 hours later, we discover that SocGen part two has struck, this time via a UBS' ETF trader (the same as Jerome Kerviel), who has been identified by the FT as 31 year old Kweku Mawuli Adoboli. The trade in question that resulted in the $2 billion loss and forced the arrest of the trader is unknown but very much irrelevant: he was over his risk profile and nobody had stopped him: this reflects very badly on UBS. And, as yesterday, we are certain that even more blow ups, at prop desks and otherwise, will now come out of the woodwork," he writes.

More from Mindful Money:

Plenty of white collar crime, but where are the “Criminals?”

UBS rogue trader: How did it happen again?

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