Natexis hit by heavy equity derivatives losses

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 €30 million from exotic option positions,” said a dealer from the equity derivatives group at another European bank, who spoke to RiskNews on condition of anonymity. The spokeswoman declined to state the size of the losses, but said capital markets net profits would lie between €15 and €30 million for H2. The bank made an overall net profit of €90 million in the first half.

While the structured equities departments of most banks have faced a torrid 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. “Certain anomalies in the data fed into the models have also been detected.”

The spokeswoman said Natexis's management was aware that some of its models used in equity derivatives valuation were “old”. But she added that the extreme volatility in the equity markets during July and August 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 in July.

Natexis said it only uncovered the losses two days ago, and that its internal investigation had taken the most corrective action required to resolve the matter.