This is one of the largest trading companies in Japan and the largest participant in the physical market for copper, with its volume being twice that of the second largest participant. Sumitomo reported a loss of $1.8 billion in copper trading on the London Metal Exchange (LME), on 13 June 1996. The loss was blamed on Sumitomo's chief copper trader at the time, Yasuo Hamanaka, who traded in operations in commodity derivatives. Tomiichi Akiyama (Akiyama), the president of Sumitomo at that time was quoted as saying that the transactions were made solely by Yasuo Hamanaka himself and accused him of abusing Sumitomo's name to carry out unauthorised trading. This loss was the largest unauthorised trading-related loss incurred by any Japanese company during that time and followed the collapse of UK's 233-year-old Barings Bank (mentioned above) and the Japanese bank Daiwa, which lost $1.1 billion in America's Treasury bond market in September 1995 due to unauthorised trading activities of Toshihide Iguchi, a New York based trader (ICMR, 2004).
17. Orange County
The county stunned the markets in the end of 1994, announcing a loss of $1.6 billion, "the largest loss ever recorded by a local government investment pool." This led to it's bankruptcy, shortly afterwards. What led to this was the lack of supervision of the investment activity carried out by the County Treasurer, Bob Citron. Under his trust were a $7.5 billion portfolio, which belonged to county schools, cities, special districts and the county itself. Citron invested in derivatives to increase profits on the pool and leveraged the portfolio to the hilt. This investment strategy worked fine until 1994, when the Federal Reserve began a series of interest rate hikes which, consequently caused losses to the pool. This unrealised "paper" loss soon caused the county to declare bankruptcy and liquidate the portfolio, realising the loss (Jorion, 2009).
18. Long Term Capital Management (LTCM)
LTCM was initially enormously successful and considered the darling of Wall Street. It was considered exceptional among hedge funds because of the large scale of its operations and size of its positions in certain markets, with annualised returns of over 40% in its first years. According to some in the industry, LTCM's counterparties often treated it more like an investment bank than а hedge fund. Even though leverage was the key to LTCM's high returns, it also exaggerated LTCM's losses (The President's Working Group 1999).
According to LTCM officials, LTCM was counterparty to over 20,000 transactions and conducted business with over 75 counterparties. LTCM started as an arbitrage fund but shortly became more of а worldwide asset allocator fund, focusing in the bond trading. LTCM's previous models proved to be ill prepared for the Asian financial disaster and the free fall in Russian bonds.
LTCM lost $4.6 billion in less than four months during 1998 and went out of business in early 2000. It became the most prominent example of the risk potential in the hedge fund industry.
19. Amaranth Advisors LLC
The natural gas trader, a multi-strategy hedge fund founded by Nick Maounis in 2000 (one of the largest US hedge funds), lost about US$6 billion in a week, making it the largest financial loss made by a single trader. Burton and Leising (2006) stated that in June 2006, the company energy trades accounted for about half of the fund's capital and generated about 75% of their profits. Rick Brooks, a financial planner in Solana Beach, California, noted that the term "hedge fund" is very generic and compared it to saying that one is a doctor. Just as physicians run the gamut from brain surgeons to podiatrists, hedge funds vary generally in terms of investment strategy and risk level. However, hedge funds do share some extensive similarities. For beginners, like a mutual fund, a hedge fund puts investors' money to work in the market. However, a significant difference is that these hedge funds are private and usually fell beyond the reach of government regulation. Although they did not have to register with the regulator in this case the Securities and Exchange Commission (SEC), the hedge fund managers had certain fiduciary responsibilities to their investors. Also, because hedge funds under this legislation are not allowed to advertise and promote their operations, they are generally recognised as secretive or enigmatic. Information on particular hedge funds is not available, to some extent, because managers do not want to unintentionally do something that might trigger regulator's inquiry (in this case it was the SEC).
20. Kidder Peabody
The activities of a single trader, Joseph Jett, led to this New York investment dealer losing $350 million trading U.S. government securities and their strips. Strips are created when each of the cash flows underlying a bond is sold as a separate security (Hull, 2009). This involves separating the bond's principal and interest components into two separately traded issues. If the demand for bonds is higher than for the strips, as many as 60 interest payments (zero-coupon bonds) could be reconstituted into a traditional coupon-bearing bond (referred to as a "recon") (Freedman et al, 2001). As Freedman and Burke (2001) noted the IT system was not capable of "making dozens of zero-coupon bonds disappear in a reconstitution and then making a conventional bond materialise,"the exchange was recorded as the sale of the zeros and the purchase of the coupon bond. It however, inappropriately allowed settlement of "recons" up to five days in advance. He would buy strips and sell them in the forward market. Jett entered into "forward" contracts, and at a later date, he would join the principal and interest components together. This enabled Jett to record the profits on the same day that he entered them and that would then disappear off the books by the time the trade was settled. He would then roll them over instead of settling them, leaving the profit on the books and continually increase the value of his portfolio in order to keep the system going. This is how the large volumes of trades in early 1994 has been explained.
21. Bank of Montreal
Disclosed on April 2007, that it had lost up to $407 million trading in natural gas. BMO Chief Executive Officer Bill Downe said in a conference call that the loss resulted from inaccurate valuations on the bank's large portfolio of natural gas out-of-the-money options. Out-of-the-money refers to a price that is less favourable than what's currently available in the market, triggering a loss for an investor. Most of these trades were made by David Lee, a veteran gas trader at the bank (Alexander, 2007).
22. Italian Bank Italease
Banca Italease's principal activity is the provision of leasing and factoring services to financial institutions, commercial entities and other financial operators. Other actions involve property management and other financial services.
According to an article, in The Telegraph(2008) by Evans- Pritchard, on 29 June 2007 Banca Italease, announced huge losses of roughly $610 million on credit derivative swaps involving Deutsche Bank, Paribas and Societe General. They also announced an additional $120 million in potential losses.
The derivatives losses stunned Milan's banking organisation and exposed the concealed dangers of exotic credit instruments. The Bank of Italy also instructed Banca Italease to seek capital increases and to terminate selling of derivative contracts of any form. Infact as the Bank noted ccommissions were down by 37%, mainly an indication of Italease's exit from the derivatives business. The bank's factoring business grew by 24% to €9.5bn and it increased its market share in the following six months in spite of its derivatives troubles.
According to Davide Navasotti, risk manager for Milan-based bank Meliorbanca, 'what was missing at Italease was an adequate risk management and the implementation of Basel II policies' (Evans-Pritchard, 2008). Banca Italease has restructured its risk management and control processes after declaring а net loss of about €686 million from its derivatives business. As European interest rates started to increase the barriers were breached causing large mark-to-market losses for the bank. Banca Italease has closed the majority of its derivatives transactions with bank counterparties and as of 23 July 2007 had derivatives contracts with а net positive mark-to-market value of about €3 million outstanding(Evans-Pritchard, 2008).
23. Deutsche Bank AG
Considered to be the largest bank in Germany, lost more than $400 million on 27 October 2008, They were trading equity derivatives during a time when the stock markets faced a great upheaval similar to that of the 1930s (Simmons and Keehner, 2008). The performance of the financial contracts, whose valuations are based on fluctuations in other assets, was adversely affected by the increase in the correlation between the equity markets. This led to deterioration of the value placed on the residual derivative positions reaped from the activities in retail structured products (Simmons &Keehner, 2008).
24. BAWAG P.S.K.
(Bank für Arbeit und Wirtschaft AG) Austria's fifth-largest bank, owned by the Austrian Trade Union Federation (Ã-sterreichischer Gewerkschaftsbund, Ã-GB) in 2006, was purchased by Cerebus Capital after an investigation revealed $2.4 billion in losses ensued from failed bets against the yen and derivative dealings, using currency and interest rate swaps. The bank had been involved in obscure derivatives trading with Refco, an insolvent US futures broker.Helmut Elsner, BAWAG's former chief executive and Wolfgang Floettl, fund manager, were sentenced for their roles in causing the losses (The Times-Seib, 2008). HorowitzC. , 2006 in his article 'Scandal at Union-Owned Bank in Austria Cuts Wide Swath' blamed what happened on the greed of the people who ran BAWAG and noted what Nicola Venedey, a senior analyst at Moody's Investor's Service in London, said "Their risk appetite was very high, and their transparency was very low."
Under the successive CEOs Walter Flottl and especially Helmut Elsner, BAWAG invested heavily in risky derivatives managed by Ross Capital Markets Ltd., a Bermuda-based hedge fund run by Walter Flottl's son, Wolfgang. Theseinvestments only proved to be profitable for a few years and then lost out mainly resulting from bad bets noted above.The bank also lost anestimated $13.2 million stake in a gambling casino in Jericho in the Palestine West Bank, run by an investment group fronting for PLO Chairman Yasser Arafat, the casino raked in large profits, but closed about a month after a violent Palestinian uprising in October 2000. (Horowitz, 2006)
When his successor, Ewald Nowotny, took office in January 2006, he immediately promised to cease all 'exotic trading' and to clear up all businesses causing major financial problems for the bank. Moreover at a press conference on 24 March 2006, Günter Weninger, the Chair of the BAWAG Supervisory Board, announced the bank's accumulation of losses during the previous five-year period and stated that he had been informed of these losses by management at the end of 2000. However, he had decided to conceal the losses in derivatives trading for fear of triggering a bank run by customers and thus possible insolvency (Adam, 2006).
25. Allied Lyons
The treasury department of this drinks and Food Company lost $150 million in 1991 selling call options on the US dollar-sterling exchange rate (Hull 2009). As noted in the Financial Times, 20 March 1991 cited by Howell and Bain (2005) in their book 'The Economics of Money, Banking and Finance', this was attributed to 'abnormal foreign exchange exposures'. The company had a large portion of dollar-based income from both operations and exports and used derivatives to hedge against adverse currency movements. It took heavy positions on the expectation of dollar weakness, taking positions in both the derivative and cash markets, writing call options on the dollar, and selling the dollar short in the foreign exchange market. Although, as noted, it is quite common for large companies to write call options, this practice should be approached with caution since this leaves the writer with unlimited exposure (Howells &Bain, 2005 pg 439).
26. Gibson Greetings
The treasury department of this greeting card manufacturer in Cincinnati lost about $20 million in 1994 trading highly exotic interest rate derivatives contracts with Bankers Trust. They at first entered into plain vanilla swaps with Bankers Trust to convert their bonds to floating rates. When these were terminated, at a gain, they were converted into structured swaps. They received a 5.5% fixed rate and paid LIBOR squared divided by 6%. As the LIBOR went up, they became expensive and to avoid paying cash on termination, entered into more complex swaps with Bankers Trust. Their non-performing assets now rose to $167.5 million without relation to any underlying liability. Bankers Trust gave inaccurate valuations to understate unrealised losses (Gopalakrishnan, n.d.). Gibson Greetings later sued Bankers Trust and settled out of court (Hull, 2009).
27. Hammersmith and Fulham
This British Local Authority lost about $600 million on sterling interest rate swaps and options in 1988 following movements in sterling interest rates. They had entered into about 600 interest rate swaps and related instruments with a total notional principal of around £6 billion for speculative rather than hedging purposes. The two employees did not have a good understanding of the transactions and risks they were taking. The British courts later declared all of the contracts null and void. This was obviously unfavourably received by the banks on the other side of the transactions, since there was no authority to carry out the transactions (Hull, 2009).
28. Procter and Gamble
The treasury department of this large U.S. Company lost about $90 million in 1994 trading highly exotic interest rate derivatives contracts with Bankers Trust. They later sued Bankers Trust, claiming that Bankers Trust did not 'accurately and fully' disclose information about the derivatives contract, and settled out of court (Hull, 2009). Procter and Gamble had been using derivatives instruments to cut the cost of its borrowing and manage its exposure to interest rate and foreign exchange using swap transactions. However, as noted by Howell and Bains (2005) in their book 'The Economics of Money, Banking and Finance', the company took out two highly geared swaps contracts, designed by Bankers Trust to allow Procter and Gamble to swap fixed interest rate loans for floating interest rate loans, on the assumption that US and German interest rates would remain low. As the interest rates rose sharply, Procter and Gamble lost money on the contracts, which they later said were inconsistent with the company's internal policy on the use of derivatives. As noted above Bankers Trust were also sued at the same time on similar grounds by another American company, Gibson Greetings (Howells &Bain, 2005: 438).
29. The currency crisis in Southeast Asia
Here companies (two of these - Kashima Oil and Showa Shell Sekiyu K.K. aresummarised above) used derivatives regularly to bet on movements in interest rates and currencies. Despite the insistence of the governments within the region that their currency would hold against the dollar, during the onset of the crisis, the players who desired huge profits held twice the possessions of speculative currency derivatives (Adams and Runkle, 2000). The losses remained on their books, as speculators held the contracts till they matured (Borsuk and McDermott, 1998).
