The Role of Supervision in the Derivative Trading: Towards a "New Pillar" of Individual Behavior's Control

Evidences from the recent financial crisis highlighted the difficulties of financial authorities in order to prevent risky behaviours of single financial intermediaries that caused the collapse of the system. The need of an upgrade in the regulatory system arises. In particular, the change from a system based on the formal respect of single rules to a new system founded on an effective monitoring of financial behaviour is needed. An analysis of real bank and corporate financial behaviours during the crises is useful in order to understand the deficiencies of both supervisory and internal control systems. The responsibilities, ascribed to financial derivatives in order to explain the genesis of the crises and the consequences of their use on financial balances of both financial and corporate firms, make a focus on this topic quite interesting. An analysis of financial disasters caused by derivatives in recent years suggests the central role of single rogue traders in the defaults that follow high derivative trading losses. From a regulatory perspective, the need to add a new pillar, with a focus on an “individual supervision”, to the previous supervisory framework, that already contemplates systemic and corporate pillars, is quite clear. A supervisory system not able to monitor the risk management behaviour of single traders will undermine the competition level within the market. Market players that follow the risk management supervisory rules will be penalized compared to other players that ignore them and decide to overcharge their risk exposure by financial derivatives, in order to obtain large returns. The consequences, due to the lack of control, will be even stronger if the risky players will have the awareness of the possibility that a Government financial bailout will cover potential future trading losses. The paper analyses the role of rogue traders in different financial disasters (in banking and non-banking cases), due to derivatives trading, in order to provide some policy suggestions to both financial authorities and top managers. Results highlight the need to strictly monitor the traders’ activities and personal attitudes, when they have a key role in the trading desks, as well as the need to promote and develop a “culture of control” within financial intermediaries. Anyway the authors know very well that the development of a culture of risk management can be obtained only in a long-term perspective and it needs continuous efforts in order to monitor and stimulate the process.