How To Repair An $8b Hole

The best guides to fixing the hole in Societe Generale that derivatives trader Jerome Kerviel drove a $8.2 billion truck through are Australian. SocGen's chairman, Daniel Bouton, and the governor of the Bank of France, Christian Noyer, can find them on NAB's website.

The foreign exchange trades that cost NAB $360 million in 2004 are chickenfeed compared with SocGen's loss, which was pencilled by Kerviel losing bets that sharemarkets would rise, and inked by the bank itself when it discovered the positions, and sold them just as global markets were tanking earlier this week.

But there are many similarities, chief of which is that Kerviel circumvented SocGen's internal controls. Just like NAB in the early days of its disaster, SocGen is in denial.

Bouton says internal controls have been tightened and Kerviel and his immediate supervisors stood down, but he also apparently believes that the bank is a victim of a hit-and-run - that Kerviel, a relatively junior trader, has single-handedly deceived all the bank's systems with an "extraordinarily sophisticated" web of fake transactions. In a separate statement, the bank offered that the debacle was an "isolated and exceptional ... fraud".

One hopes not, in a way: better to discover that SocGen's systems failed than to believe they were solid - best in industry, many believed - and so easily bypassed. We need to know, that's for sure, and the two reports prepared in the wake of NAB's foreign exchange debacle in 2004 are still world-class blueprints for the job.

One is by the prudential regulator in this country, APRA, and the other, commissioned by NAB itself, is by PricewaterhouseCoopers.

Both are forensic works, and both identify firstly that the losses were caused by rogue trading, initiated in pursuit of profits, magnified repeatedly in an attempt to recoup losses, and methodically and meticulously concealed. But both then go on, to investigate how the subterfuge could have succeeded, and their conclusion is the same: protection against a rogue trade event is the product of excellence in three interacting areas: governance, culture and risk management controls.

PWC summed up NAB's shortcomings on that triple front most succinctly, stating in its report that poor supervision had enabled the rogue currency traders routinely to exceed their trading limits (the bank's value-at-risk ceiling was breached repeatedly, with the knowledge of superiors), that internal control systems were inadequate (a one-hour lag in the system of reporting trades was a key weakness the traders exploited), and that a series of internal warning signs were either ignored, or lost in the system, right up as far as the board's audit committee.

Overlaying it all, PWC said, was a culture thatfocused excessively on good news, and profits. NAB's board simply "was not informed of important issues", the report concluded.

NAB accepted the findings, and cleaned up its act according to an APRA template that for a time saw it holding extra capital against assets, restricting currency trading and benching its internal risk capital assessment formula. APRA also oversaw cultural changes that included wholesale renewal of the board and senior management.

All that for $360 million? No. All that because a bank of the standing of NAB should never be in the position where losses are generated that way.

Exactly the same principle applies to SocGen - even more so, arguably, in light of the fact that the French bank was one of the four mega-players in equity derivatives, alongside BNP Paribas, Deutsche and Goldman Sachs. Confidence in the derivatives market was already at a nadir ahead of SocGen's revelation. The sooner the bank and its prime regulator get on with a full autopsy and overhaul, the better.

There were suggestions yesterday, by the way, that SocGen's decision to begin closing out Kerviel's book at the beginning of this week was responsible for the selldown that in turn spurred the US Fed chairman, Ben Bernanke, to cut rates by three-quarters of a percentage point on Tuesday night.

But even before the European markets opened and SocGen acted, the futures markets were pointing to a 500-point loss on Wall Street.

The potential loss that Bernanke acted to head off grew a bit after SocGen moved to liquidate the rogue trader's positions, for sure. But the mood was already doom-laden.

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Necessity was the mother of invention with the confirmation by Centro's new boss, Glenn Rufrano, this week that the group wants to avoid directly selling properties to ease its debt burden, and will instead look to either raise new capital directly or sell its stakes its Centro Australia Wholesale Fund and Centro America Fund.

Direct property sales are a toxic option for Centro because ownership of group properties is split between Centro companies, funds and outside investors who participate through syndicates. Unlike Centro, they are not under pressure to sell.

Centro would hope to raise $1.5 billion if it sells out of the two wholesale funds, and does not have to raise the rest of its $3.9 billion debt overhang as equity. It just has to raise enough to allow the full total to be refinanced in a debt-equity package. An alternative is a full equity injection into Centro, with $2 billion probably handing over control.

Centro's data room opens next Tuesday, and there is reported to be solid investor interest in the various options - but the process has no hope of meeting the February 15 debt refinancing deadline that the company faces.

The 14.5 cents jump in Centro's price to 62.5 cents yesterday and gain of 75 per cent leaves Centro far away from its 52-week high of $10.06 last May, but does show growing confidence that a deadline extension is likely, partly because the banks will want to protect Centro's property and funds management income, which KPMG has valued at $5.5 billion.

US banks in the lending syndicates hold the key, and Rufrano is talking to them next week.