THE SUMITOMO

COPPER
DERIVATIVES
DISASTER

USEFUL INSTRUMENTS OR WEAPONS OF MAS

DESTRUCTION ?

HOW IT BEGAN

Sumitomo Corp. was one of the top five Sogo-Shosha,

general trading companies in Japan.
Yasuo Hamanaka (called as "Mr. Five Percent & "Mr. Copper)
was the head of copper trading at Sumitomo prior to 1996.
Sumitomo Corp. was speculator until late 1980s. It acquired
mines in the Philippines in 1984, which changed its position
from speculator to supplier.
His main strategy was the short squeeze.
He was buying futures and choosing physical delivery .
He stored it in the warehouse, thereby creating lack of
copper in the market.
Future sellers ended up buying copper in a spot market,
resulting in backwardation: the spot price is higher than the
forward price.
He sold put options to collect the premiums as he
thought he can push the prices up, thus writing put options was
not risky for him.

THE TRAP

In December of 1991, LME decided to set new regulations that

would limit the range of backwardation within 25 pounds
to prevent market manipulation. It a huge loss in Sumitomos
portfolio. To recoup the loss, he conducted a Radr
transaction in June 1993.

Radr transaction steps :

$
1900

$ 2140

LME, however intervened again to avoid market domination by setting

new rules that limited backwardation within $5, and, to increase
market control, LME forced Credit Lyonnais Rouse, a major
counterparty of Sumitomo Corporation, to reduce its positions. Based
on these regulations and changes, Sumitomo ended up closing their
Radr position and incurred a $1.1 billion loss.

THE FINAL BLOW

The market conditions changed in 1995, with resurgence

of mining in China.
increase in the supply put more pressure on the
market for a correction.
The company was left in a bind because it still was long
on copper when it was heading for a big drop. Worse
yet, shortening its position - that is, hedging with shorts which would simply make its significant long positions lose
money faster, as it would be playing against itself.
While Hamanaka was struggling over how to get out with
most of the ill-gotten gains intact, the LME andCommodity
Future Trading Commission (CFTC) began looking into the
worldwide copper-market manipulation.

AFTERMATH OF THE SCANDAL

Sumitomo responded to the probe by "transferring"

Hamanaka out of his trading post.
Copper plunged, and Sumitomo announced that it had lost
over $1.8 billion, and the losses could go as high as $5
billion, as the long positions were settled in a poor market.
They also claimed Hamanaka was arogue trader and his
actions were completely unknown to management.
Hamanaka was charged with forging his supervisor's
signatures on a form and was convicted for 7 years.
Sumitomo responded to the allegations by implicating
JPMorgan Chase and Merrill Lynch. Sumitomo blamed the
two banks for keeping the scheme going by granting loans to
Hamanaka through structures like futuresderivatives. All
of the corporations entered litigation with one another,
andall were found guilty to some extent.

LESSONS LEARNT

Management-Level control: Sumitomo Corporation failed to

execute a consistent management job rotation policy.
His dominant position in the copper market made him
untouchable inside the corporation as well as outside and no
one dared to look closely at his transactions.
Independent Transaction Monitoring: Sumitomo should
have created a separate and independent supervisor system
within the company hierarchy to avoid these agency issues. In
fact, after 1996, many governmental agencies, including ones in
Japan, established new rules that provided that the middle and
back office should be totally separated from the front office.
Corporate Responsibility: We should also consider corporate
responsibility with regard to timely reporting. In the Sumitomo
case, the management waited ten days until issuing a press
release. It could have avoided additional declines in copper
prices that were caused because of the rumors and uncertainty
in the market.

LME Regulation: Copper could not easily be transferred

around the world to meet shortages. The arbitrage
opportunity in price differences could be easily offset by
additional delivery and storage costs.
Government Regulation: The regulatory agency should
have executed more stringent rules on the derivatives
market to avoid price manipulation and impose new
regulations on corporate reporting obligations so as to
provide investors and other market participants with
greater information regarding the organizations
willingness to take risks and capability to manipulate
market prices.

THANK YOU