Sunday, January 27, 2008

Societe Generale: a proud giant laid low

The initial reports are confirmed; Kerviel used hacking to hide his trades: stolen passwords, fake accounts, deep knowledge of the risk management systems. The Times correctly reports (unlike, e.g., the network news this weekend) that although SocGen's losses in closing out the positions totaled around $7 billion, the size of the actual positions was an order of magnitude larger.

Below is some background on Societe Generale, the second largest bank in France, originally established by Napoleon. Their equity derivatives business accounts for 20 percent of total profits and employs 3,500 people. (As I mentioned in a previous post, none of the U Oregon honors college students I polled knew what a derivatives trader was. France on the other hand is traditionally strong in mathematics and finance.) Legendary figure Jean-Pierre Mustier helped pioneer the derivatives business in Europe.

NYTimes: Mr. Mustier, a native of Clermont-Ferrand in the Auvergne region of France, has become the bank’s point man on the scandal, shepherding reporters through the details of Mr. Kerviel’s trades while frequently conferring with his boss, Daniel Bouton, the bank’s chief executive.

And as a former student at two of France’s most elite engineering schools — the École Polytechnique and the École des Mines — Mr. Mustier, 47, exhibits the cool, disciplined style that alumni of those institutions are known for.

When asked what his personal reaction was to the rogue trades, he said, “It was not the time for personal feelings, but for actions.”

Although the local cemetery that abuts Société Générale’s mirrored headquarters on the outskirts of Paris might give more superstitious employees pause, the bank’s traders have long been known for the cockiness that comes with high salaries and pedigrees from France’s best engineering schools. (In fact, Mr. Kerviel’s salary of roughly 100,000 euros, or $147,000, would have put him at the low end of the bank’s pay scale for traders.)

And Société Générale traditionally has shown more boldness than other, more conservative giants of French industry. When French banks were privatized in the 1980s, Société Générale was the first to emerge from government control, starting in July 1987. Mr. Mustier’s innovative derivatives trade on the Paris Bourse, in fact, took place just two months afterward, in September 1987.

Mr. Mustier was recruited to the bank by Antoine Paille, a fellow whiz kid who graduated from the École Nationale de la Statistique et de l’Administation Economique, before starting the bank’s derivatives desk in the mid-1980s.

With French banks still sleepy after decades of state control and far behind their more aggressive foreign counterparts in global capital markets, the two men set out to make Société Générale a world leader in the emerging field of derivatives.

And by hiring young mathematicians and quantitative analysts, or quants, from the Grandes Écoles, the country’s prestigious and highly elitist state schools, to help them create complex formulas that are the bedrock of the trade, they managed to do that.

From just 25 people in 1990, the equity derivatives division at the bank now employs 3,500 people. (Mr. Paille has since left the bank and is a derivatives executive at Commerzbank of Germany.)

In 2006, Société Générale earned 5.2 billion euros in net income. Its corporate and investment unit contributed 2.3 billion euros to the bank’s profit.

Profit in the field pioneered by Société Générale mounted as swiftly as one of the graphs in of their elegant mathematical models. Over all, the bank’s derivatives unit accounts for an estimated 20 percent of the bank’s total profit, according to various estimates by analysts.

And until the fraudulent trades, the company’s shares had outperformed those of its European peers, including bigger rivals like Deutsche Bank and BNP Paribas, for six of the last eight years.

According to a Merrill Lynch report from December, Société Générale expected a 10 percent growth in its equity derivatives business this year thanks to retail customers and emerging markets growth. What is more, because it relies so much on computer programs and systems, rather than on manpower, the business is highly profitable.

Mr. Mustier and Mr. Bouton will be spending the coming days answering questions about how Mr. Kerviel could possibly have wagered more than $70 billion without being detected — and whether he had indeed acted alone, as they both insist. But broader questions are likely to be asked about the safety of the derivatives business and whether French banks have placed too many of their bets on it.

“What used to be an excellent management team sitting on an enviable retail franchise and a global leadership position in derivatives is now a management under pressure suffering from a lack of confidence,” the Merrill Lynch analysts Antonio Guglielmi and Alberto Segafredo said in a recent report.

1 comment:

steven rix said...

Now the societe generale is going to challenge the dog of Jerome Kerviel, i'm sure it had all the secret codes to do the financial manipulations.
The guy was betting way too much for a simple trader and everything was fine as long as the bank was making money...

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