Tighter controls likely after SocGen debacle

London investment banks face the likelihood of closer regulation of derivatives trading in the wake of the rogue trader debacle that cost French bank Société Générale an estimated €4.9bn ($7.2bn).

Bosses at the Financial Services Authority (FSA) including chief exec Hector Sants called senior execs at London banks on Thursday and Friday urging them to tighten up internal controls and risk management, the Sunday Times reports.

The paper adds that the UK regulator plans to introduce guidelines on derivatives trading in a bid to prevent a repetition of the lack of control that allowed software developer turned junior trader, Jérôme Kerviel, to place huge bets on growth in European stock exchanges that backfired spectacularly and left the Paris-based bank with such serious losses.

An FSA spokeswoman declined to discuss the possibility of introducing tighter regulation in the wake of the scandal suggesting it was too soon after the affair emerged for it to issue formal guidance. The UK regulator seems inclined to let its French counterparts deal with the aftermath of the mess while keeping its own counsel, at least publicly.

City sources told the Sunday Times that a variety of new regulations over derivatives are planned and may be introduced in a matter of weeks.

A more rigid separation of staff who deal with settlement and compliance in banks is also on the cards. The regulator may also call for additional vetting of staff who move from IT functions to become traders, a career path Kerviel followed before his spectacular fall from grace. It may also ask banks to reduce the backlog of trades, a factor reckoned to have contributed to the late discovery of problems on Société Générale's books.

The Sunday Times adds that the FSA and French regulators will also liaise together in an investigation designed to uncover whether anyone profited from insider knowledge about the vulnerable position Société Générale was left in as a result of Kerviel's trades.

London's equity markets are far bigger than those in France. City specialists quizzed by El Reg said that Société Générale operates in a less strict regulatory regime over the channel, but that "doesn't mean it couldn't happen here".

French regulators leading the probe into SocGen's derivatives business are likely to uncover evidence of other unbooked trades, emails to headhunters, evidence of surfing pornographic websites and other potentially embarrassing material, he added.

Security and usability often conflict. Setting up a locked-down system free of the loopholes exploited by Kerviel while retaining usability could prove a huge challenge. "To re-engineer a trading system that's secure and auditable is at least as big a challenge as Y2K remediation," said our source. "If you lock systems down you could end up putting padlocks on fire doors - preventing authorised people from getting out in an emergency as well as preventing those outside getting in."

Kerviel’s losses are reckoned to be the biggest ever attributable to a rogue trader. The investment banking world, already struggling to deal with the financial instability caused by the sub-prime crisis, has been dealt another sharp body blow. Speculation is mounting that Société Générale could be vulnerable to a hostile takeover bid.

Meanwhile, Kerviel, the man at the centre of the scandal, faces some awkward questions from French financial police after turning himself in on Saturday. ®