Sunday, September 19, 2010

Auditing Derivatives:Think of what can go wrong- The Trading Floor


This article appeared in The Malaysian Accountant journal , June-July 2010 issue

In the current crisis of derivatives, the job of auditors, both internal and external is being put to the test. There is always the danger that even the most thorough job can leave some holes uncovered, which may (and normally does) blow up one day. While it is imperative to understand the business and how derivative products work, a crucial prerequisite is for auditors to have the right mindset.
Thinking of what can go wrong is a sound foundation to detect potential weaknesses. This is even more so for derivatives in the investment banking industry, which are constantly increasing in complexity.
Countless recent case studies can point us to potential areas of weakness. This series of articles will explore the things that can go wrong by analysing the various functions within an investment bank.  To start, let us begin where all trades originate and profits (and losses) are generated – the trading floor.

Traders’ risk limits increased when he continuously outguesses the market
Trading limits are sometimes breached denoting excessive risk taking. But a bigger worry is when