Société Générale, 2008

At a glance

What happened

Société Générale's arbitrage desk was supposed to run small, hedged positions. Through 2007 and into January 2008 one trader built enormous unhedged long positions in European index futures, around €50bn, and entered invented offsetting trades so that every net exposure report looked normal. The fabrications were found on 18 January 2008. The bank sold the whole position over the next three trading days, while European stock markets were falling sharply, and ended with a loss of €4.9bn.

Why it went wrong

The fake trades were placed where the controls were weakest: counterparties whose confirmations were not chased, trade types with deferred settlement, and trades cancelled and re-entered just before the checks that would have caught them. The trader knew which reconciliations ran and when because he had worked in the middle office. Controls that compared net positions could not see an invented other side. Then a large part of the loss came from the exit itself, selling a huge position in a falling market.

What it teaches

Controls only check what they are designed to check. Confirmation with an outside counterparty matters more than internal consistency, and alerts closed by asking the person being flagged are not controls. The cost of unwinding belongs in any risk assessment: a position is only as safe as the market's ability to absorb it on the day you have to leave.

Key terms

Fictitious trade

An invented offsetting position booked to make a real exposure appear hedged.

Confirmation

Agreement of a trade’s terms with the counterparty — the check an invented trade cannot survive.

Exception handling

What happens after an alert fires, and the step that decides whether a control works at all.

Delta One

Desks trading instruments that track their underlying one-for-one, such as index futures and swaps.

Unwind cost

The loss incurred while exiting a position, distinct from the loss the position already carried.

Supervision

The obligation on a desk head to know what the desk holds, which no system replaces.

Where it sits in the course

Case studies like this one are used throughout risk management teaching, including FRM® preparation, as worked examples of operational risk: rogue trading and the cost of the unwind. In OTC Learn the lesson runs in five steps: what happened, the position, why it broke, what it cost and what it teaches, followed by a worked example with the numbers. See the lesson outline.

Related case studies

• Barings, 1995One trader, both sides of his own desk
• Archegos, 2021Five banks, one position, and none of them could see it

The instruments behind it

OTC Learn lessons on the products this case turns on:

• Equity SwapSwap equity returns for a funding rate