Accidents and major problems, when they occur, often tend to get bunched together "" if only by chance. The two institutions currently experiencing this are surely Deutsche Bank (DB) and the Tokyo Stock Exchange (TSE). |
Readers of pink papers will recall the comments made by Anshu Jain, the head of global markets, Deutsche Bank, when he visited India a couple of months ago. While paying the usual lip service to the importance of India to the bank's business "" such comments from visiting dignitaries have by now become a cliche "" he also exhorted Indian authorities to liberalise the derivatives market. (One does not know about the benefit of this to the economy in general, but surely ever more complex derivatives are extremely lucrative for banks marketing them.) Jain's enthusiasm for derivatives is, of course, understandable "" he has risen through DB's investment bank, which makes a lot of money trading them. |
Little would Jain have foreseen that, within a few months, his bank would face losses and supervisory inquiries in relation to some complex derivative transactions in its London office: specifically, synthetic CDOs (Collateralised Debt Obligations); and highly complex credit derivatives based on a standard index of the prices of credit default swaps (CDSs). Such instruments are illiquid and, therefore, often valued according to mathematical models, in the absence of market prices. (Incidentally, Enron was a notorious user of mark-to-model energy derivatives). Therefore, the valuations are as good or bad as the models used. In this particular case, a review of the valuation system disclosed overvaluation by $50 million. Anshul Rustogi, the trader involved and incidentally an alumnus of IIML, has been dismissed by DB. |
DB is also facing two other major embarrassments. In Italy, its controversial role in the attempted takeover of Banca Antonveneta by another Italian bank is under scrutiny. (Incidentally, after hanging on to his post for months after that scandal broke open, the governor of the Bank of Italy has been recently forced to resign because of his somewhat over-liberal attitude towards acceptance of costly gifts from cronies whose own actions required the central bank's blessings.) The third case is more mundane "" but also arises from difficulties in valuation of illiquid assets. DB was/is managing a real estate mutual fund. For the past couple of years, with the slowdown of the economy, the German commercial real estate market has been soft. As asset values started falling, investors in open-ended funds started redeeming their investments and the fund had to bring more and more property in the market for sale, putting further downward pressure on prices: financial markets are of course all too prone to such vicious circles. |
The redemption pressure became so strong that DB was forced to suspend fund operations. The revalued portfolio's NAV turned out to be about 10 per cent below the last published number. The investors who had not redeemed lost a packet of money. Initially, DB refused to accept responsibility for the losses, or compensate the investors. Under pressure from the regulators, it has had to back-track, and has now agreed to offer at least partial compensation. |
The Tokyo Stock Exchange Students of mathematics are aware of the chain rule: a*b=b*a. In financial markets the rule does not always hold good as Mizuho Securities found in a recent trade on the Tokyo Stock Exchange. It was a costly lesson to learn, the cost being as high as almost $ 400 million. It was a simple mistake which anybody who uses a keyboard and a menu on the screen, could have committed. Instead of ordering the sale of one share of a company, at ¥600,000, by mistake, the trader placed an order for selling 600,000 shares at ¥1 each! Obviously, the sale offer was snapped up by buyers, and Mizuho had to buy shares at the market price to effect deliveries, thereby incurring the huge loss. Incidentally, while some of the buyers have offered to pay back the windfall gains, not all feel that they are morally or legally obliged to do so. And, even those who agree, are unwilling to do so unless everybody else does. |
As if the Mizuho case was not enough to damage the reputation of the world's second largest exchange, a few days later TSE was forced to close trading 20 minutes early as the system could not cope with the volumes and a collapse was feared. As customary in such cases in Japan, TSE's Chief Executive has since resigned. |
Clearly, the Mizuho case has thrown up several issues which risk managers, including in India, need to think over: |
Email: avrco@vsnl.com |