The man, named by Sky sources as Kweku Adoboli, was arrested at 3.30am on suspicion of fraud by abuse of position and remains in police custody, sources said.
The bank, which has 6,000 staff in the UK and an office in the heart of London, revealed earlier that a trader had lost an estimated two billion US dollars on unauthorised trades.
A memo issued to UBS staff by chief executive Oswald Gruebel said the alleged rogue trading, which he called "distressing", was discovered in the past 24 hours.
Adoboli, whose parents are from Ghana, worked in the European equity trading division of the group and was based in London. He has worked at UBS for at least five years.
Adoboli was described as 'very popular' with colleagues (Pic: Facebook)
An acquaintance described the former University of Nottingham student as a "nice, open guy with lots of friends, very popular with his colleagues and personal friends".
She told Sky News Online: "I would have thought many of his colleagues and friends are very shocked at the news."
A former landlord said he was "a very nice guy".
Philip Octave, who rented a flat in Shoreditch, east London, to Adoboli for £1,000-a-week until he moved out four months ago, said: "I haven't got a bad word to say about him.
Notorious Rogue Trader Losses
:: Nick Leeson lost £800m in 1995 which led to the collapse of Baring's Bank.
:: Japan's Daiwa Bank lost $1.1bn in 1995 through bond trader Toshihide Iguchi.
:: Societe Generale trader Jerome Kerviel lost £3.8bn in 2010.
"He was very well spoken and dressed very smartly. I can't believe that it (the rogue trader) is him."
Sky's Mark Kleinman said colleagues who worked alongside Adoboli have been sent home.
"A failure of risk management has clearly taken place," Kleinman said.
The bank, which has offices in the heart of the City of London, has not revealed details about the activities but they are said to involve a Swiss franc transaction that went wrong after the Swiss National Bank intervened to lower the value of its currency.
Adoboli began working for UBS in 2006 (Pic: Facebook)
Adoboli is understood to have worked with a product called an Exchange Traded Fund (ETF), an investment fund traded on stock exchanges, much like stocks, which holds assets such as stocks, commodities, or bonds.
According to the Financial Services Authority (FSA) register, Adoboli started working for UBS as a trainee investment adviser in March 2006 and has had no disciplinary action taken against him previously.
A report by the SWX Swiss Exchange lists Adoboli as a "market maker" - someone who provides buy and sell prices to a bank's clients in a particular market.
The FSA is now in close contact with its counterpart in Switzerland and with UBS, which is carrying out an internal investigation.
It has said no customer accounts were affected. Shares in the bank tumbled by more than 7% in early trading today and UBS warned that the activity could have tipped the bank to a third-quarter loss.
The allegations have already drawn parallels with the case of British trader Nick Leeson, whose activities led to losses of £800m and the collapse of 233-year-old Barings Bank in 1995.
Leeson, who was tracked down and sentenced to six and a half years by a Singapore court, eventually wrote a book about his experiences which became a Hollywood film starring Ewan McGregor and Anna Friel.
Rich people tend not to want to do business with a bank where there are questions over risk control.
Jerome Kerviel was jailed in 2010 for three years by a Paris court and ordered to repay 4.9bn euros for his role in a trading scandal at French bank Societe Generale. He claimed the bank knew about the risk-taking.
Zurich-based UBS, which employs 65,000 worldwide, has been hit by global growth fears. Last month it said it would be reducing its headcount by 3,500 as part of a bid to save two billion Swiss francs (£1.5bn) by the end of 2013.
The bank had only just started to see client confidence return this year after it had to be rescued by the Swiss state in 2008 following massive losses on toxic assets held by its investment bank.
ETX Capital Analyst On How Loss Was Detected
Louise Cooper, markets analyst at BGC Partners, said the loss will call UBS's risk management into question and an unexpected trading loss could do "significant reputational damage" to the bank.
She said: "Rich people tend not to want to do business with a bank where there are questions over risk control."
Analysts have said the news will spark further debate about so-called casino banking - UBS revealed the loss days after a major report said UK banks should protect customers' savings from being used in their investment operations.
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