Course Title: FINANCIAL DERIVATIVES

Course Code: FIN-647, Sec: 1

ASSIGNMENT
on
" A Case Study on Société Générale’s Big Loss "

Submitted to
Mohammad Arman, Ph.D.
Assistant Professor
Department of Accounting & Finance
School of Business & Economics
North South University

Submitted by

Group-03
Name ID Signature

Kawsur Ahmed Sojib 161 2197 060

Mohammad Ali Noor 143 1116 060

Naznin Rahman 162 1206 060

MD. Abu Jawad Khan 162 1715 060

Shima Rahaman Srity 161 1563 660

Date of Submission: 19th April 2018

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 A Case Study on Société Générale’s Big Loss

The purpose of this case is to study the financial mishaps occurred in Société Générale at

2008, due to inappropriate use of derivative instruments by Jérôme Kerviel. The data and

information used during the study are collected from secondary sources related to the case,

like online blogs and news articles which are mentioned in the bibliography.

Case Summary:

Société Générale (SocGen) is one of the largest banks in Europe. It was founded by a group

of French entrepreneurs in 1864. The bank had been constantly innovating and developing for

over a century. However, in the year 2008, Société Générale was thrown into turmoil because

of a rogue employee, Jérôme Kerviel. The rogue trader executed a series of fictitious

transactions that cost the company more than €4.9 billion, a figure far higher than the bank's

total market capitalization. Jérôme Kerviel used his knowledge of the bank’s procedures to

speculate while giving the appearance of arbitraging.

In January 2008, his unapproved trading was revealed by Société Générale. Over a three-day

time span, the bank loosened up his situation for lost 4.9 billion euros. This was at the time

the greatest loss made by deceitful movement ever in finance. The Ex-Société Générale trader

Jérôme Kerviel was condemned to 5 years imprison by a French court and ordered to repay

€4.9 billion to the bank due to fraudulent exercises and additionally breaching of trust.

Involved Transactions & Strategies:

Jérôme Kerviel was instructed to look for arbitrage opportunity in financial markets. He used

to trade in German DAX index, the French CAC 40, London FTSE and the Euro STOXX 50.

However, the transaction position he took on STOXX was beyond his trading limits. Jérôme

Kerviel took long position in a portfolio by buying 30 billion euros’ worth of Euro STOXX

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stock index futures contracts, 18 billion euros of German DAX index futures and 2 billion

euros of London FTSE futures[CITATION Kim16 \l 1033 ]. Kerviel specially focused on the

EURO STOXX index which is considered super-sector leaders in the Euro Zone. Initially, the

market favored him and his speculation resulted enticing profit. This encouraged him to make

large bets and take big positions in equity index options on STOXX.

Kerviel was highly skilled and cunning trader. Due to his previous employment in Société

Générale’s mid-level management, he had in depth knowledge on IT control and authorized

system access. The main strategy of Kerviel was to conceal his speculative positions by

showing well-structured fictitious transactions. Through exploitation of bank’s IT control and

access system he gave an appearance of arbitraging to all his transactions. In reality, he had

large bets on index directions far beyond his limited authority. He was also a computer genius

and was able to breach five level of controls. In attempt to hide his activities, Kerviel used

fake e-mail messages to justify missing trades, and he also the borrowed his colleagues' log-

in credentials to conduct trades in their name. All these strategies allowed him to perform

huge speculative derivative transactions from 2007 to 2008, under the nose of Société

Générale’s risk-management department[CITATION Pet08 \l 1033 ].

What Went Wrong:

A large portion of Jérôme Kerviel’s speculative transactions had maturity of 1 to 3 months.

The risk limit of trading was not specifically defined by the bank. Kerviel’s desk trading limit

was €135 million which could exceed to €200 million but he breached the limit and took long

in future of €50 billion which was double the bank itself [CITATION Kim16 \l 1033 ]. Kerviel’s

unauthorized trading of this scale may have gone unnoticed initially due to the high volume

in low-risk trades normally conducted by his department.

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Inevitably, in January 2008, Jérôme Kerviel’s speculation went wrong as stock index prices

went down because of financial crisis and individuals were unwilling to buy stocks for fear of

losing money. That’s how stock price was falling down and Kerviel betting position started to

lose money. As he didn’t enter into any offsetting contracts, the loss could not have covered

by shorting other stocks. When situation worsened more and more, bank surveillance

discovered the trade that crossed the risk threshold. Kerviel got fired but bank executives still

had to deal with the €50 billion worth of long futures, which at that point had effectively lost

€0.95 billion[CITATION Nic08 \l 1033 ]. So, they decided to sell the position as soon as possible.

The Person Responsible:

Jérôme Kerviel was responsible for the losses of Société Générale. He graduated in 2000

from University Lumiere Lyon 2 with a master of Finance specializing in organization and

control of financial markets and joined Société Générale as middle officer and began working

in the compliance area. In 2005, he was promoted and became a junior trader in the bank’s

Delta One products team. His job was to look for arbitrage opportunity in financial markets.

He exceeding his credit limits and involved in Freudian activities.

In 2008, his unauthorized trading was uncovered by Société Générale. Over a three-day

period, the bank unwound his position for a loss of 4.9 billion euros. Société Générale

characterizes Kerviel as a rogue trader and claimed worked these trades alone and without its

authorization.

Lessons from the Case:

The lessons from these losses of Société Générale are very noteworthy for any derivative

instrument user.

 The lesson we get, at first, is, defining risk limits for traders is a must for any financial

institution like bank using derivatives instruments. And the top or board level
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 management should be more restrictive in case of risk limits of an individual trader so

that it allows the bank to stop any offender before things get worse as it did in this case of

Société Générale by Kerviel.

 Secondly, the enforcement of strict managerial control and employee supervision should

be ensured to avoid any violation in derivatives transaction. The management should be

observant about traders trading pattern and traction as well as their positioning on the

derivatives. If Société Générale had proper management control and employee

supervision system, it would have been a lot tougher for Kerviel to carry through such big

transactions. Kerviel changes its arbitrage position to speculative position secretly but

management did not know the fact. It indicates poor management of the bank. So, it’s not

only about more control, but also the better quality in the control should be considered.

 Another issue is the internal IT control and authorization access systems. Safer IT

systems including up-to-date access control for the traders and employees will minimize

such risks. In the system there should be firewall or special authentication for the

transaction where top level’s endorsement is a must. Then no individual traders cannot

involve in any fictitious transaction and even if it occurs, the top level can easily identify

that before. For example, had Société Générale employed stronger dual-factor

authentication rather than single-factor authentication, it could have been utterly

impossible for Kerviel to bypass the system easily.

 Additionally, the management should keep separated front, mid and back office along

with strong authentication procedure, so that any personnel in a particular department

could not exploit the organization’s system and promoting to another department must be

prohibited.

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 Furthermore, Both the management and the traders should not underestimate the immense

benefits of diversification. If Kerviel took short position in any other stock index then he

could offset his loss from long position in various stock indexes.

 Finally, companies engaged in financial business should asses, at initial phase while

recruiting, the trader’s behavior which will allow them to understand the risk aversion

degree of the trader.

Conclusion:

From the study of the case it can be concluded that Jérôme Kerviel as well as Société

Générale’s loopholes in both internal policy and management are evenly liable for such kind

of derivative losses. Most companies spend their time on protecting themselves from external

threat, but the internal threat can posture much bigger risks. In the case of Société Générale,

we have seen the severity of such internal risk. Thus, any derivative instrument user should

emphasize on internal risks as well as external risks for avoiding unforeseen losses.

BIBLIOGRAPHY

Iskyan, K. (2016, May 8). How Jerome Lerviel Lost 72 Billion. Retrieved from Business

Insider: http://www.businessinsider.com/how-jerome-kerviel-lost-72-billion-2016-5

Nicola Clark, D. J. (2008, January 28). Société Générale loses $7 billion in trading fraud.

Retrieved from NY Times:

http://www.nytimes.com/2008/01/24/business/worldbusiness/24iht-socgen.5.9486501.html

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Peter Sayer, T. W. (2008, April 17). What You Can Learn about Risk Management from

Societe Generale. CIO.

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