Reconciliation catches the trade that is not there

Graduate · enrolled learners

This lesson opens with Allied Irish Banks and John Rusnak, 2002.

What happened

John Rusnak was a currency trader at Allfirst, the US subsidiary of Allied Irish Banks, and over about five years he hid roughly 691 million dollars of trading losses by entering bogus offsetting options trades into the bank's systems. His real currency positions were losing badly, but the fake options made his book appear hedged and within limits, so on paper the risk looked balanced. The fabricated trades were never independently confirmed with the counterparties they were supposedly done with, because the back office did not chase confirmations for them, accepting his explanations, so the fake hedges sat on the books unchecked against the outside world. Reconciliation, the process of confirming that every trade recorded in the system actually exists as a real deal with a real counterparty, would have exposed the fake options immediately, since a trade with no counterparty on the other side cannot be confirmed. The loss grew for years not because the fabrication was clever but because the one check that would have caught it, confirming the trades were real, was not performed on the trades that mattered.

The decision point

Reconciliation is the process of independently confirming that every trade recorded in a firm's systems actually exists as a real deal with a real counterparty, and it is the specific control that catches a fabricated trade, because a trade that was never done has no counterparty to confirm it, so it fails the moment someone checks. Allied Irish Banks is the case: John Rusnak hid about 691 million dollars of losses by entering fake offsetting options that made his book look hedged, and they survived for five years only because the back office did not independently confirm them with counterparties, the exact check that would have shown they did not exist. This is the concrete control behind the course's theme that a rogue-trading loss is a control failure first: the fake hedge is the classic tool, making a losing book appear balanced, and reconciliation is its classic antidote, because a fabricated trade cannot be confirmed by a counterparty who was never party to it. The danger is that the fabricated trades are exactly the ones a firm might not scrutinize, since they make the risk look fine, so the trades that most need confirming are the ones that make the book look safe. So the discipline is to independently confirm every trade against the counterparty, to treat the trades that make a book look hedged with special suspicion rather than relief, and to never let the person who entered a trade also vouch for its existence, because Allied Irish shows that a fake hedge is only real until it is checked against the outside world, and a firm that does not confirm its trades is trusting the trader to have told the truth about whether they happened at all.

Recorded loss

$691,000,000

Orientation and Year One are open: anyone can read them without an account. From Year Two onward the lessons are for enrolled learners, because progress through the later years only means anything if it is tracked against a record.

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