Natexis loses in equity derivatives

New angles

Paris-based Natexis Banques Populaires has announced that it has made “significant losses” in its equity derivatives trading business due to poor risk control and failures in its valuation models. Natexis, 75% owned by the Banque Populaire group, said in December that the losses stemmed from structured equity products trading for the second half of last year. The bank is investigating the matter and has fired up to six staff, according to a Natexis spokeswoman.

The French bank said the revaluation of its short- and medium-term derivatives positions would “carve a large slice” out of its capital markets group profits for the second half. “We’ve heard that they [Natexis] may have lost as much as e30 million from exotic option positions,” says a dealer from the equity derivatives group at another European bank, speaking on condition of anonymity. The spokeswoman declined to state the size of the losses, but says capital markets net profits would be between e15 million and e30 million for the second half of 2002. The bank made an overall net profit of e90 million in the first half of last year.

While the structured equities departments of most banks have faced an adverse trading environment in the past few months, Natexis admitted that its risk management processes had failed to effectively manage its exposures. “The difficulties are exacerbated by the inability of certain valuation models to successfully manage the current extreme volatility,” the bank said in a statement released on December 6. “Certain anomalies in the data fed into the models have also been detected.”

“Old” models

The spokeswoman says Natexis’s management was aware that some of its models used in equity derivatives valuation were “old”, adding that the extreme volatility in the equity markets during July and August last year caught bank staff by surprise.

A number of dealers have expressed concern that newer entrants in the structured equity products market are failing to manage their risks correctly. Products with embedded cliquets – derivatives equivalent to a series of forward starting, at-the-money options – are especially difficult to risk manage. This is because a fair valuation requires the correct pricing of the elusive forward volatility smile – the variation of an option’s volatility with strike price and maturity. “Mis-pricings are difficult to prove, but we definitely see competitors with prices that seem inconsistent to us,” Lionel Crassier, Paris-based head of exotic trading in the equity derivatives group at BNP Paribas, told Risk last July (Risk July 2002, page 22).

Natexis says it only uncovered the losses at the start of December, and that its internal investigation has taken corrective action to resolve the matter. Credit rating agency Moody’s has placed the Natexis Banques Populaires’ B– financial strength rating on review for possible downgrade. However, Moody’s maintained all other ratings on Natexis and its parent Banque Populaire Group.