Allied Irish Banks and Allfirst, 2002

Fake options, real losses, and rates the trader supplied himself

A foreign exchange trader at Allfirst, the US subsidiary of Allied Irish Banks, lost about $691m over five years trading the yen against the dollar. He hid the losses with fictitious option trades that appeared to hedge his real positions, persuaded the back office not to confirm them, and fed the exchange rates used to value his own book. It was discovered in February 2002, and the independent report that followed became a reference text on trading controls.

Open in the app · Case Studies · intermediate

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What the lesson covers

1. What happened
2. The fake options
3. The other gaps
4. What it cost
5. What it teaches

Key terms

• Trade confirmation — Agreement of a trade’s terms with the counterparty, the proof that the trade exists.
• Independent price verification — Checking the rates and prices used to value a book against sources independent of the trading desk.
• Prime brokerage — A service in which one bank clears, settles and finances a client’s trades executed with other dealers.
• Net settlement — Settling many trades as one payment, which can hide individual positions if not reconciled trade by trade.
• Deep in the money — An option whose strike is far from the current price in the holder’s favour, so it is worth almost its intrinsic value.
• Value at risk — An estimate of the loss a portfolio should not exceed over a period at a given confidence level.

Every key term, A to Z

In practice

Unconfirmed trades are now escalated after a set number of days regardless of counterparty, market data for risk and valuation comes from a price-verification function independent of the desk, and prime brokerage and net-settled activity is reconciled position by position to the trading book.

Read next

• FX Option — The right to exchange currency at a strike
• FX Forward — Lock in a future exchange rate
• Société Générale, 2008 — Fictitious hedges, and a €4.9bn exit

In the app, Allied Irish Banks and Allfirst, 2002 carries a five-step lesson, a worked example and a bank of twelve questions drawn differently every sitting.

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