Yasuo Hamanaka, head broker of Sumitomo Corporation, manipulated world copper prices on the London Metal Exchange from 1991-1995. By taking large long positions and reporting fake trades, he generated profits but faced losses when prices fell. Sumitomo lost $1.8 billion when Hamanaka's scheme was uncovered. The disaster showed the need for transparency in commodity markets and limitations on individuals' power to curb manipulation.
Yasuo Hamanaka, head broker of Sumitomo Corporation, manipulated world copper prices on the London Metal Exchange from 1991-1995. By taking large long positions and reporting fake trades, he generated profits but faced losses when prices fell. Sumitomo lost $1.8 billion when Hamanaka's scheme was uncovered. The disaster showed the need for transparency in commodity markets and limitations on individuals' power to curb manipulation.
Yasuo Hamanaka, head broker of Sumitomo Corporation, manipulated world copper prices on the London Metal Exchange from 1991-1995. By taking large long positions and reporting fake trades, he generated profits but faced losses when prices fell. Sumitomo lost $1.8 billion when Hamanaka's scheme was uncovered. The disaster showed the need for transparency in commodity markets and limitations on individuals' power to curb manipulation.
Yasuo Hamanaka, head broker of Sumitomo Corporation, manipulated world copper prices on the London Metal Exchange from 1991-1995. By taking large long positions and reporting fake trades, he generated profits but faced losses when prices fell. Sumitomo lost $1.8 billion when Hamanaka's scheme was uncovered. The disaster showed the need for transparency in commodity markets and limitations on individuals' power to curb manipulation.
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Derivatives are often referred to as financial instruments of mass destruction,” due to all
derivative disasters which have occurred in the past and companies going bankrupt it has created a negative reputation and derivatives are not a financial instrument suitable for everyone. Derivatives without a doubt are risky yet the current situation happened as a result of the greed, over positive speculation of budgetary foundations and absence of precautionary measures. The derivatives market has developed significantly since the 1990s, with more speculators, brokers and traders purchasing futures, forwards, hedging contracts and benefiting from the complex financial instruments that make up the derivatives market. With all the investors high dependency on removing risk has been raising the threat of speculators manipulating derivatives market. Regardless of the intrinsic usage of derivatives it has been generally used by investors to speculate future prices and bet in pursuit of windfall gains. Investors gamble with enormous amounts of which are not in their power or control the cash in stake is so tremendous that a wrong derivative decision can bankrupt the whole company and bring a bad reputation which will affect the company for decades. In this part of the assignment we are examining a past case for one of the biggest derivative disasters which arose through manipulation in commodities and how the future of futures trading was affected.
Sumitomo Corporation scandal
How the disaster happened Yasuo Hamanaka was the head broker of Sumitomo Corporation who was accused of manipulating the world copper prices through his activities on the London Metal Exchange (LME) copper futures market during the time of 1991 to 1995. This counterfeit forged increment in copper prices brought about huge profits for Sumitomo Corporation by selling copper. In addition, Hamanaka reported increased trading profits to the board of directors by presenting of fictitious trading transactions, which he had made through a nexus with certain brokers. At any point if a hedge fund or a speculator who knew about the manipulation and took short positions, Hamanaka had to put more money into his positions therefore maintaining the stated high price (Engdahl 1996). Furthermore, in spite of these illegal actions no move was made against Hamanaka because of the profits he produced for the company. Manipulation of the copper prices were conceivable because of absence of straightforwardness in the reports of major clients at LME. During late 1995, as copper production expanded in various facilities especially in China, copper prices began to decrease. This was unfavourable for Sumitomo as he had bought long positions in the copper futures market. Hamanaka failed to sell off his long positions. So, he attempted to recover the losses by taking large positions in copper futures on the London Metal Exchange. As the trading numbers were huge, it created attention and it gave a warning to Hamanaka (Weiser 1996). Hamanaka then made an arrangement with Merrill Lynch for US $150 Mn, which gave him authorisation to trade through Merrill Lynch at LME. Afterward anyway when LME began investigation on the alleged accusation for manipulating copper prices. Due to this Hamanaka was taken off from his position of head trader which eventually brought short brokers and hedge funds into the act accordingly, which caused copper prices to fall further on LME. Even though the transactions were made exclusively by Yasuo Hamanaka himself, He used Sumitomo's name, and proceeded with unapproved trading and even borrowed money from a few banks with no approval from his senior board members. Hamanaka a middle level director who got so much power simply because of the way that he had helped Sumitomo earn a great deal of profits earlier. He was given a lot of duties by the company, a lead trader position and his sole controllers were abroad, a long way from Tokyo. Sumitomo Corporation lost around USD 1.8 billion in copper futures. This is an exemplary instance of – ‘Running on the top of tiger not knowing how to get off without being eaten. In September 1996 Sumitomo Corporation accounted 1.8 billion US dollars as a loss on derivatives which was about 10% of Sumitomo's yearly sales. (Engdahl, 1996)
Main reason for this disaster was manipulation of world copper prices due to lack of transparency in accounting records of major clients at LME (Wudunn 1996). Commodities Futures Trading Commission (CFTC) who controlled US futures required transaction records of all major clients on all US trades. But it was not the situation with Securities and Investments Board (SIB) who supervises London Financial markets. Financial Services Act under which the financial markets of United Kingdom are monitored also neglected to give any appropriate arrangements if there should be an occurrence of any price manipulation. In this way the regulators had no guidelines to recognise the potential manipulating situations or act against it.
What can be learned from this disaster.
Controllers should now be more mindful and proactive than any time as there more possible approaches for price manipulation by companies because derivatives provides a great opportunity with its complexity and high leverage. Companies should limit themselves from vesting a lot of authority on one particular individual and pursue a hierarchy approach. By creating fictional trades and manipulating accounting records, Hamanaka effectively misdirected the board of directors to trust that he was making genuine profits.
This example is a good example why self-regulation is important in derivative trading. Often companies and investors are attracted why the huge amounts of money that can be gained using derivatives which lures them with greed in order to make huge profits. But it with a proper framework and guidelines such mishaps can be avoided. On numerous occasions lessons are not learnt and mistakes are repeated, and investor’s hard-earned money has been robbed and a lot of companies go bankrupt.
Nevertheless, derivatives markets consist of numerous financial instrument choices with
various risk depths and various flexibilities that can be suited to each company and investor. A decision gone right or turned out badly can turn change the company as well as the whole industry. Opportunities are limitless and the profits are high, and a lot is at stake. Yet, all the derivatives should come with a notice; “Handle with Care.” References
1. Capelle-Blancard, G 2010,” Are derivatives dangerous? A literature Survey”, Dans
Economie Internationale, vol 3, no 123, pp 67-89, date retrieved 27 April 2019, <https://www.cairn.info/revue-economie-internationale-2010-3-page-67.htm#>
2. Engdahl, W 1996, “The Sumitomo crisis: more than meets the eye”, EIR Economics, Vol 23, No 27, PP 4-6.
3. Weiser, B 1996,” The lessons of the copper caper”, Washington Post, 8 September, retrieved 25 April 2019, < https://www.washingtonpost.com/archive/opinions/1996/09/08/the-lessons-of- the-copper-caper/fa175db3-3536-425e-ac70- c56a7370b40c/?noredirect=on&utm_term=.acb9f94296aa>
4. Wudunn, S 1996, “Behind Sumitomo scandal: a drive to be a copper king”, The New York Times, 6 July, retrieved 25 April 2019, <https://www.nytimes.com/1996/07/06/business/international-business-behind- sumitomo-scandal-a-drive-to-be-the-copper-king.html>
