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LONDON-Financial institutions worried about their exposure to losses from rogue traders have a new coverage option.
Lloyd's of London has launched a new fidelity insurance policy designed to protect financial institutions from the risk of losses from rogue trading by employees-including those who incur losses trying to trade their way out of a loss, as well as employees motivated by personal profit. The policy provides up to $250 million of coverage.
The Lloyd's Unauthorised Trading Policy has been developed by underwriting agency SVB Syndicates Ltd., with coverage provided by Lloyd's syndicates 1007 and 1212, which SVB manages.
According to SVB, the policy plugs a hole in the fidelity insurance market that until now has left most financial institutions without protection against some kinds of financial fraud committed by their employees.
However, J.P. Morgan & Co. Inc. and FMR Corp. each have structured programs that cover rogue trading (BI, Aug. 11).
Stephen Burnhope, a director of SVB Syndicates, explained that the policy is unique in that it covers a financial institution's losses caused by a rogue trader, even in cases when that trader was not dealing for his own gain. In at least one previous precedent-setting legal case, a bank's insurers did not reimburse it because the trader, although she had exceeded her trading limit and caused losses totaling millions of dollars, had done so only to make up earlier losses.
Mr. Burnhope said a dozen banks so far have shown interest in the policy, and three have asked for quotations. However, he believes the potential market is many times bigger.
The policy initially will be marketed primarily to existing Lloyd's clients, which currently include 60% of the world's largest 100 banks, 70% of the 50 largest U.S. banks and 80% of the biggest U.K. banks, according to SVP.
To qualify for coverage, banks will have to demonstrate certain internal controls are in place, such as written trading policies and procedures and independent oversight and review of trading activities. Loss-making trades within a dealer's authorized limit will not be covered.
Mr. Burnhope said the risk of a "bad apple" rogue trader is always a concern for senior management even in the best-run institutions. "We believe this new product will be in strong demand by bank directors as a backstop to prudent controls and will become a standard line of cover purchased by larger institutions," he added.
The relevant clause in SVB's Unauthorized Trading Policy, which will protect financial institutions in such cases, says compensation will be paid for "direct financial loss. . .caused by unauthorized trading by any trader while trading for the assured, which unauthorized trading was concealed or was falsely recorded."
Other standard policies do not provide this protection for financial institutions. Professional indemnity policies cover liability for clients' losses due to negligence or errors but do not cover the institution's own account loss. Fidelity policies do cover the institution's own account loss, but only from theft or other dishonest or fraudulent acts intended to cause a loss, or for an employee's own personal financial gain.
They do not cover the financial institution in cases such as the one in 1995 where Barings P.L.C. lost 864 million million ($1.40 billion) through the actions of rogue trader Nick Leeson. While Mr. Leeson's trades in stock index futures were unauthorized, the bank was not protected because he had not exceeded his trading limit to make a personal profit for himself, but rather to make up earlier losses. The SVB policy will fill this gap, Mr. Burnhope said.
The policy provides coverage limits of up to $250 million for the policy period, which can range up to three years. Rupert Villers, a director of SVB Syndicates and underwriter of syndicate 1007, said, "We certainly aim to build up this sum assured over time."
There is a policy deductible of $10 million to $25 million. Annual premiums will range between $2 million and $10 million.