Derivatives Disaster Sumitomo

sumitomo Corporation Sumitomo Corporation – The story of Copper derivatives Incident:  This study is a classic example of – ‘Running on the top of the tiger not knowing how to get o without being eaten.’  Yasuo  Yasuo amanaka! the chief copper trader at "apan#s $umitomo %orporation caused caused &'.( &'.( billio billion n losses losses to the compan company y throug through h his unauth unauthori) ori)ed ed tradin trading g acti*it acti*ities ies in the physical physical and futur futures es market market in copper copper at the +ondo +ondon n ,etal ,etal -xchange. t was the largest unauthori)ed trading/related loss incurred by any  "apanese company during that time. time.

Analysis: Initial Prots – Result of Manipulation  Yasuo  Yasuo amanaka the head trader of $umitomo %orporation manipulated the world copper prices through his operations on the +,- 0+ondon ,etal -xchange1 copper copper futur futures es marke markett o*er o*er the period period of 2332/34 2332/34.. This This arti5c arti5cial ial increa increase se in copper price resulted in increased pro5ts for $umitomo %orporation from selling copper. copper. ,oreo*er ,oreo*er amanaka was reporting reporting in6ated trading pro5ts pro5ts to the top mana managem gement ent by sh show owing ing in*o in*oic ices es of 5cti 5ctiti tiou ous s opti option on trade trades! s! whic which h he had had crea create ted d thr through ough a nexu nexus s with with some some brok brokers ers.. 7hen 7hene* e*er er any any hedg hedge e fund fund or spec sp ecul ulat ator or who who was was awar aware e of manip manipul ulat ation ion trie tried d to tak take sh shor ortt posi positi tion ons! s! amanaka in*ested more money into his positions thus sustaining the high price. owe*er despite these faulty practices no action was taken against amanaka because of the pro5ts he generated for the company. company.

Lac !f Transparency $ucc $ucces essf sful ul manip manipul ulat atio ion n of the the copp copper er pric prices es was was poss possibl ible e due due to lack lack of  transparency in the reporting positions of large clients at +,-.

Action Taen Too Late 8uring late 2334! due to increased copper production facilities particularly in %hina! copper prices started declining. This was ominous for $umitomo as they had had long long posi positi tion ons s in the the futu future res s mark market. et. ama amana naka ka faile failed d to get get rid rid of his positi positions ons.. e tried tried to reco* reco*er er the losses losses by taking taking huge huge positi positions ons in copper copper commodity futures on the +ondon ,etal -xchange. owe*er the huge *olume of  trad tradin ing g attra attract cted ed the the atte attent ntio ion n of the the exch exchan ange ge and and it ga*e ga*e a warn warnin ing g to amanaka. amanaka then struck a deal with ,errill +ynch for 9$ &24: ,n! which enabled him to trade *ia ,errill at +,-. +ater howe*er when +,- started

in*estigating on the alleged manipulation of copper prices amanaka was taken o from his position of head trader. This brought the short traders and hedge funds into the act causing the copper prices to fall further on +,-.

Lac of Proper Mana"erial Supervision and !perational Control Systems  Transactions were made solely by Yasuo amanaka himself. e abused $umitomo#s name! and continued on with unauthori)ed trading and e*en borrowed money from se*eral banks without any authori)ation from his seniors. amanaka a middle/le*el manager got so much power only because of the fact that he had helped $umitomo garner a lot of pro5ts in the past. e was gi*en a great deal of responsibility by the company! a star trader status and his only regulators were o*erseas! far from Tokyo.

Lac of Monitorin"  Trading in commodities and 5nancial instruments was not being properly monitored by the go*ernment regulatory agencies and by the companies undertaking these transactions. This conclusion can be deri*ed from the fact that in a short span of 2( months three ma;or deri*ati*e disasters were seen< •

9=#s '>>/year/old ?arings ?ank! which lost & 2.@ bn in Aebruary 2334 due to Bick +eeson#s unauthori)ed trading acti*ities in the $ingapore futures

market  "apanese bank 8aiwa which lost &2.2 bn in Cmerica#s Treasury bond market

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in $eptember 2334 due to the unauthori)ed trading acti*ities of Toshihide guchi.  "apan#s $umitomo %orporation &'.( billion losses due to unauthori)ed

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trading acti*ities in the physical and futures market in copper at the +ondon ,etal -xchange.  The debacle was the result of $umitomo#s poor managerial! 5nancial and operational control systems. 8ue to this! amanaka was able to carry on unauthori)ed trading acti*ities undetected by the top management. The *esting of excessi*e decision power on a single employee and failure to implement the  ;ob rotation policy were the other reasons cited.

#ama"e Control Measures n order to control mounting losses! $umitomo began aggressi*e liDuidation of its unco*ered positions in the copper physical and futures market under its new president =en;i ,iyahara. t cancelled its plans to buy back ': million of its shares and award Yen 2': million 0&2.2 million1 of bonuses to its senior

managers. $umitomo was able to o*ercome the losses since it had a net worth of  &( bn and another &E bn in hidden reser*es. The losses estimated to be &'.( bn amounted to only 2: per cent of $umitomo#s annual sales.

Conclusion $ lessons learnt from derivatives F8eri*ati*esG are complex bank creations that are *ery hard to understand! but the basic idea is that you can insure an in*estment you want to go upby betting it will go do%n. The simplest form of deri*ati*e is a short sale< you can place a bet that some asset you own will go down! so that you are co*ered whiche*er way the asset mo*es. Harticularly! the $umitomo case resulted in tighter internal super*ision and control procedures by trading 5rms and 5nancial institutions the world o*er. 8isclosure must lead to a serious introspection among *arious 5nancial regulators and trading 5rms to impro*e the existing regulation and super*ision procedures. Regulators ha*e now become more aware and proacti*e than e*er before as the possibilities to manipulate the markets ha*e become more practical with the ad*ent of complex and high le*eraged instruments like deri*ati*es. Hre*ention here is always better than prosecution. %ompanies should also restrain themsel*es from *esting too much power on a single employee and follow a ;ob rotation policy. ?y entering into 5ctitious trades and manipulating accounts! amanaka successfully misled the management to belie*e that he was making huge pro5ts. $ound operational and monitoring system need to be in place to keep track of acti*ities of traders. $uccessful traders might reDuire more! not less! scrutiny.