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WEB EXCLUSIVE: There’s trouble brewing

Oh Boy. If you thought the Société Générale saga was beyond belief – today we learn that Eurex, the derivatives exchange, had been trying to warn the French bank for two months about Jerome Kerviel’s extraordinarily large trading volumes – then I invite you to contemplate the £274 million loss clocked up on hedging transactions by Mitchell & Butlers.

29 January 2008

5:30 PM

29 January 2008

5:30 PM

Oh Boy. If you thought the Société Générale saga was beyond belief – today we learn that Eurex, the derivatives exchange, had been trying to warn the French bank for two months about Jerome Kerviel’s extraordinarily large trading volumes – then I invite you to contemplate the £274 million loss clocked up on hedging transactions by Mitchell & Butlers.

Oh Boy. If you thought the Société Générale saga was beyond belief – today we learn that Eurex, the derivatives exchange, had been trying to warn the French bank for two months about Jerome Kerviel’s extraordinarily large trading volumes – then I invite you to contemplate the £274 million loss clocked up on hedging transactions by Mitchell & Butlers.
 
Who? Would that be Mitchell & Butlers the Mayfair-based boutique investment bank, or Mitchell & Butlers the lesser-known Wall Street commodity trader? No, its Mitchell & Butlers, the former brewer, once part of the Bass Charrington combine, that owns All Bar One wine bars and Harvester Inns. Perhaps some distant memory comes back to you, as it does to me, of sitting in a big, dank pub somewhere in the Midlands about 30 years ago, drinking fizzy brown beer and wishing you were somewhere else. Well, that’s the Mitchell & Butlers we’re talking about, and it all goes to prove that the brave new world of financial engineering really is open to all-comers.
 
These days, you don’t have to be a giant multinational bank to make a giant loss trading in obscure instruments that your director don’t understand. That was the ‘90s. In the 21st century, even dull old pub companies with flat beer and flat profits that want to turn themselves into hot young pub companies with whizzing shareholder returns can do it. In M&B’s case, they’ve done it in spades.
 
Our friends at M&B are, or were, very much in the latter category. Like several other major British brewers, they decided some time ago that it was best to leave the actual brewing to foreigners; better returns were to be had from rolling out trendy pub and ‘leisure’ formats, and punting around in property. Last year, in the course of trying to arrange a cash-generating, sale-and-leaseback joint-venture with property tycoon Robert Tchenguiz involving some 1,300 of their pub properties, M&B were persuaded by their City advisers – Citigroup and Royal Bank of Scotland – to take out huge hedging contracts against the risk of rising interest rates and future trends in pub rents. But the pub-property deal never went ahead, leaving the hedging contracts as an open one-way bet, which is of course the very opposite of a hedge. As Bank of England interest rates started to fall and rents started to move the wrong way, M&B’s position looked worse and worse. Finally, M&B’s board decided to close out the hedge contracts, crystallise the loss at £274 million, part company with finance director Karim Naffah, and in an exquisitely rare act of corporate penitence, cancel their own annual bonuses.
 
The net balance-sheet effect of this is equivalent to having a couple of hundred of the group’s pub properties wiped off the face of the earth, or perhaps stolen by thirsty aliens. To have left the hedge contracts in place when it proved impossible to complete the property transaction they were designed to protect was madness. But perhaps Mr Naffah and his colleagues thought they were on to such an obviously winning bet that it was well worth the theoretical downside risk. And perhaps Citigroup and RBS, having collected huge fees for setting it all up, built in such hefty penalty fees for unwinding the hedge that to do so looked prohibitively expensive from the start.
 
There is clearly more to come out on the M&B story, and more heads will roll. But as with Société Générale’s €40 billion trading positions, we can only gasp in wonder at the scale and complexity of the financial transactions that have gone wrong, their remoteness from the real-world economy, and the delusional effect their potential profits seem to have on the individuals involved.
 
From time to time, history teaches us, markets go mad: sometimes they go mad for prized physical assets, from tulip bulbs to gold ingots; sometimes they put mad values on unproven business ventures, such as nine-tenths of all the dotcom companies that were ever floated; sometimes they go mad at their own power simply to make numbers dance. That last version of financial insanity is what we have seen in this decade: the frenzied slicing, dicing, bundling and repackaging of risk until it seems to disappear up its own matrix – only to reappear in monstrous forms and unexpected concentrations. Now the financial asylum is on fire and the inmates are spilling out onto the lawn: expect to see a lot more muddled M&Bs and a couple more screaming SocGens before the men in white coats regain control.         
 
 

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