No second chance for rogue traders

Ground Floor: It's 11 years since Nick Leeson precipitated the collapse of Barings Bank and unleashed a frenzy of risk-assessment, risk-management and financial supervision models on the trading community, writes Sheila O'Flanagan

Financial institutions were quick to say that their systems would ensure that nothing like that could happen in their companies and that there was no way a "rogue trader" could cause similar problems for them.

To an extent, of course, they were right. But since 1995 we've still seen the LTCM crisis of 1998, where ex-Salomon banker John Meriwether's highly leveraged fund sparked off one of the biggest bail-outs in US financial history, as well as AIB's John Rusnak who didn't quite cause mayhem on Wall Street but sure as hell upset the boys at the bank. We've also had the occasional "fat finger" story of accidental trading, where a junior trader manages to corner the market in a particular commodity by accidentally adding a few zeros before the decimal point. Those stories tend to be one-day wonders because the futures markets quickly realise that there's something wrong and the hapless trader is usually still sitting at his or her desk hyperventilating and wondering how they're going to survive this particular blunder.

The US, Europe and Japan have all had their moments of mayhem. Now that China is a player on the world markets it's time for them to have trading problems of their own. Last year it was losses on oil swaps at China Aviation Oil, this time the commodity involved is copper which has been reaching record highs amid fears of shortages and the disappearance of Liu Qibing, a senior trader who works - maybe - for the State Reserves Bureau.

Liu built up a huge short position in copper on the London Metals Exchange (betting, therefore, that the price would fall) by selling up to 200,000 tonnes of copper he didn't have. This means that the SRB must buy back that copper in order to deliver it to the people who bought it. Unfortunately, the price has gone up by 30 per cent. And the Chinese must deliver the copper next month.

What is worrying the market is that the SRB initially seemed to deny that Liu worked for it, and then suggested that if he'd built up a short position he'd done it on his own account and not as a trader for them. Whatever Liu's prowess as a trader in the past, there's no doubt that he personally can't take a hit for a loss which is currently estimated at between $100-200 million (€85-170 million). Given that the entire market is aware of a substantial short which has to be covered by December, it's not surprising that copper prices look steamy. China has been trying to depress the price by selling metal on the domestic market, a ploy that hasn't had much effect, although it did reassure traders (temporarily) that it had stocks of copper which it could theoretically deliver. However, nobody is certain of that. There's also a very real concern that China will default on the contracts, the ramifications of which go far beyond copper trades. Once there's a short in the market, nobody is going to be the one to sell their contracts and drive the price down again.

Besides, there's a justifiable reason for prices to have increased. The Chinese demand for copper has been high, spurred on by its economic growth.

Which makes you wonder about the rationale for the trades in the first place. The conspiracy theory is that the Chinese government, under pressure from domestic copper consumers, was trying to force down prices in a strategy which has gone badly wrong. Over the past few months there have been reports in China suggesting that the SRB copper production was up and that the bureau would be releasing substantial quantities into the market, which would lead to a global surplus and falling prices. Talking your own book is a favoured strategy of a dealer with a dodgy position.

The market is afraid that the Chinese will disown the trades, leaving them with chunky losses. But, rather like the scorpion on the frog's back, traders are unwilling and unable to allow the price to decline. It might save them in the long run but it's not in their nature to avoid stinging someone else.

The copper market has seen its share of troublesome trades - in 1996 the Sumitomo Corporation lost around $2.6 billion on trading by Yasuo Hamanaka. Unlike Liu, Hamanaka had been making unauthorised transactions for 10 years before his losses caught up with him. Liu is one "rogue trader" who hasn't been able to sit around for a few years and tie up his employers in a raft of fictional accounts. Liu got it wrong and it's coming home to roost very quickly.

Non-market participants rather like seeing futures markets go into a spin. It proves to everyone that despite the vast swathes of technology that drives the market and the apparent brilliance of traders, people can and do get it wrong.

For most of us, getting it wrong means a dressing-down from the boss or being hustled out the door. For commodities traders, getting it wrong means putting world markets in a spin and having the LME and the entire financial community assess your skills and your deficiencies.

There is always, of course, the possibility of ending up as the star of a Hollywood movie too. But, in all honesty, most traders would just prefer to hang onto the day job.

www.sheilaoflanagan.net