Chris Whalen on derivatives market

One operations officer tells The IRA that his biggest headache is policing the tendency of equity traders, for example, to take punts in commodities or other asset classes, often using the same type of cash settlement index instruments employed with horrible effect by Mr. Kerviel. Such shenanigans are made possible due to the wonders of cash settlement derivative contracts. Financial contracts which settle in cash and do not require the seller to deliver some tangible asset upon maturity are gaming instruments, not investment vehicles. Such contracts actually enable young masters of the universe like Mr. Kerviel to multiply risks exponentially. The settlement procedures for derivatives also provide ample opportunities for a smart trader to game the system, thus the possible permutations of op-risk events are open-ended. The same phenomenon, incidentally, is visible in the way that third-party mortgage originators so handily gamed bank loan approval systems in creating the $1 trillion subprime structured asset debacle. Whether you speak of losses due to unauthorized trading in index contracts or write-downs of Collateralized Debt Obligations, the common cause in both cases is the unregulated and unrestrained use of derivatives to create instruments and risk exposures which are not transparent and which lend themselves to at least the appearance of intentional deception if not fraud.

~ "Rogue Traders and Economic Capital", IRI, January 28, 2008