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Risk Management

11:52 AM
Dr. John Bates
Dr. John Bates

Wave of Derivatives Risk & Fraud Scuppers Shipping Company

Ships' fuel company OW Bunker has been scuppered by a rogue wave of derivatives trades and fraudulent pirates.

A combination of out-of-control derivatives risk and systematic fraud at fuel supplier OW Bunker will cost the firm around $275 million, and has led to its bankruptcy. I believe that had the firm been using adequate surveillance and monitoring tools, this could have been avoided.

The scandal at OW Bunker, a large Denmark-based global company that supplies fuel to ships, has already led to the unceremonious sacking of its risk manager and sent some of its bankers scrambling for the exit. How could this happen? OW is one of the largest bunker (ships’ fuel) suppliers in the world. It was well-respected enough to attract nearly $900 million of investment upon its flotation in March.

Market abuse, fraud, rogue algorithms, and manipulative traders can hit any firm at any time, and on anyone’s watch. Many questions are unanswered in the OW case, but the primary ones I think are: "What risk systems and procedures did OW have in place?" and, "Didn’t the bank(s) managing OW’s IPO and potential investors look into OW’s risk management systems and procedures?" Surely this should be a top priority for anyone considering taking an interest in a risky new venture.

It appears that OW was informed of a $125 million fraud committed by senior employees in its Singapore-based subsidiary Dynamic Oil Trading, according to Shipping Watch. It is not clear whether the fraud was committed by traders or by failures in credit risk management.

If there is any lesson to be learned from the recent foreign exchange benchmarking scandal (see my blog here), it would be the need to monitor traders and other employees for fraudulent behavior. The alleged manipulation of FX prices during the one-minute 4:00 p.m. fix period was done in dealer chat rooms, where traders openly made bids and offers and disclosed deals. Their electronic fingerprints were everywhere. The patterns of abuse could have been detected, given the right monitoring and surveillance tools.  

I believe that systemic fraud, or breaches in credit limits, as may have happened at OW over a period of several months, could have been detected given these tools. Patterns of behavior, such as sums of money disappearing overnight, which were then not accounted for the next morning, could have triggered alerts to executives that something was amiss. Patterns of credit being overextended to one or more of OW’s clients over time could have alerted senior management to possible repercussions.

On top of the fraud, almost immediately prior to it being discovered, a review of OW Bunker's risk management contracts revealed derivatives trading losses of $25 million which spiraled out of control, and were last marked to market at around a $150 million loss. Again, given tools that marked positions to market in real-time and flagged up excessive settlement risk or margin breeches, this could have been nipped in the bud.

It is always easy to make these observations in hindsight, but I really believe that failures in risk controls, fraud, and even cyber terrorism are possible in the best-prepared companies. Firms need to be able to spot these threats before they can decimate their hard-won successes, or even bankrupt their companies. Following this scandal, it is clear that monitoring has to go much further than trades and data. There is always another transgression just around the corner.

Dr. John Bates is a Member of the Group Executive Board and Chief Technology Officer at Software AG, responsible for Intelligent Business Operations and Big Data strategies. Until July 2013, John was Executive Vice President and Corporate Chief Technology Officer at Progress ... View Full Bio
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