The wholesale foreign exchange market is something very mysterious, something virtual, incomprehensible to many, a challenge for others but by far the largest segment in the international financial markets. Being a trader in this market means you are probably operating in the second oldest profession in the world, attracting participants from all kinds of background.

Being active in this huge, 24 hour market, with a daily volume of USD 1,2 trillion see BIS survey of April 2001 presents many opportunities for making money if you are willing to cope with a high degree of stress. If successful, you can make a lot of money for your institution as well as yourself. Generous bonus schemes might be attractive for institutions and market participants alike, but can be - and in many cases will be the driving force behind fraudulent and/or illegal trading. Greed can play an important role next to status and image: the I can move the market mentality. All these factors are dangerous.

Over the last two years, a number of scandals have hit the reputation and image of the entire foreign exchange industry. The press tends to forget that apart from those involved in the scandal there are still thousands of individuals active in the industry who are operating under the highest ethical and professional ACI standards. These scandals can be divided into two different categories: fraudulent actions what seems to have happened in the New York case and illegal or unauthorised trading.

Those involved in fraudulent actions are using all kind of tricks to benefit financially without putting the institutions themselves at risk by taking huge unauthorised trading positions. They might be able to do so because institutions have to process thousands of deals daily, which makes it almost impossible to check each individual deal. They use the natural authority of being front-office staff to confound back-office staff. They use gaps in the organisation when authorisations and responsibilities are not clearly defined. They use lack of product knowledge in the organisation etc etc. Often they will need one or more brothers in crime but if done on a smaller scale this might not be necessary.

The other category is illegal or unauthorised trading, which really attracts the attention of the press and makes the real headlines in the papers as the amounts involved can be very substantial. Very often this problem starts as existing positions are showing a large loss. FX positions can be taken in the spot market, the outright forward market and via FX options. In order to hide the real value of the positions, off-market rates might be used in the daily revaluation process or certain positions might be rolled over on historical rates. Option transactions with far out of the money rates might be concluded to generate some cash only to cover the losses etc. People can be very creative in misleading management and back-office staff. Even more dangerous is that traders have the tendency to increase their exposure under these circumstances so that if the rates are going their way they will be able to cover their positions without any real loss. A tactic which is very seldom successful.

Who are to blame besides the traders and is there anyone else to blame? In my view many questions can be raised about the role and responsibilities of quite a few individuals. First of all a psychological issue: risk management should be considered as a protection and not as a threat to the traders. Not only because the regulators have put some guidelines in place but cooperation between front-office and risk management is essential to make this work. Is there a clear definition of the responsibilities of the front - , middle and back office? Any misunderstanding can lead to a situation where certain risks will not be taken into consideration. Frontoffice and the support area have to have separate reporting lines. Risk Management should have the authority to conduct any investigation they wish to undertake. Very important is the quality of the back-office. Are they only a processing unit or is there sufficient product knowledge available so that they can discuss problems with the front-office on an equal basis?

What is the human relationship between front and back-office staff ? Front-office staff should never use their natural authority to put pressure on back-office staff to accept certain aberrations which are in conflict with the agreed guidelines. Regulators should be aware of the internal organisation of their institutions, their respective responsibilities and guidelines and need to check this on a regular basis to make sure that all is still in order.

Fraud and illegal trading can never be avoided completely especially as more people are involved. I do not think there is a real need for more controls but present controls/guidelines should be followed more strictly and carried out by perhaps better qualified staff. Whats needed is a professional and transparent organisation, where its clear to everybody whats expected from them.