Comment: The same old story of many warnings ignored

When the Sumitomo scandal broke late last week, the position of the London Metal Exchange certainly looked an awkward one, given its supposed role as regulator of the London copper market, but even so this seemed more a case of mild embarrassment all round than one of overt regulatory failure. First impressions are often deceptive, and this one most definitely was.

Financial scandals tend to follow a well-worn pattern and it was perhaps naive to believe the LME's protestations of innocence. The pattern works thus: the scandal breaks, fraud is alleged; it then transpires that there is a history of warnings, which the regulator has investigated but eventually ignored, wrongly, as it turns out. As in so many other financial scandals, this is what seems to have occurred in the Sumitomo affair.

David Thelkeld, a former London copper trader who once dealt extensively with Sumitomo, first alerted the LME to suspect transactions by Yasuo Hamanaka more than five years ago and has been badgering the Exchange and a number of newspapers (lamentably, not us) about it on and off ever since. According to Mr Thelkeld, the authorities never took him or his allegations seriously. Rather, they treated him as wrong 'un, believing his complaints more a result of sour grapes than anything else. In the highly clubable environment of the LME, it was easy to believe Mr Thelkeld was just a trouble-maker best ignored.

As it happens, Mr Thelkeld did indeed have good reason for sour grapes. Two of his traders, Ashley Levitt and Charlie Vincent, were deserting him to form Winchester Commodities, taking the Hamanaka association and a large part of Sumitomo's highly lucrative business with them. They ended up poaching quite a few of Mr Thelkeld's staff as well. When the Securities and Futures Authority started investigating allegations of manipulation in the copper market earlier this year, it was natural its attention should turn to Winchester. As with the LME, the investigation discovered nothing untoward.

All things seem obvious with the benefit of hindsight; the perennial problem of regulators is that hindsight is not an available commodity. Their lot is to operate in the fog, without guidance or direction. Certainly it is hard to judge quite how negligent or otherwise the LME has been without knowing the full facts. David King, its chief executive, insists that when the story is finally told, the LME will emerge unblemished. And maybe he will indeed be vindicated. You wouldn't get very good odds on that, though.

The fault, in any case, may lie not so much with the LME as with the London market as a whole. The problem is that a great deal of metal trading in London is over the counter, off-market, and therefore not subject to regulation at all. Furthermore, many of the biggest operators in these markets, such as Sumitomo, are not members of the Exchange. In so far as they use the Exchange, they trade through others. Perhaps this is what the Lord Mayor, John Chalstrey, meant when he referred in his Mansion House speech last week (before the Sumitomo scandal was known about), to the lightness of the City's regulatory touch being a major attraction to foreigners.

To be fair, the growth in unregulated, over-the-counter business is not something confined either to metal trading or London. It is a world-wide phenomenon affecting virtually all financial instruments, from equities to bonds and foreign exchange. Part of the fascination with the Sumitomo affair, is that it seems to be a quintessentially modern, global securities fraud - Sumitomo, a Japanese securities house based in Tokyo, Hamanaka, an Americanised Japanese bucho (highly respected executive) operating out of New York but using London for the bulk of his trades. The world's three great financial centres are thus brought together in a manner which makes it hard to establish where responsibility lies. Add to that the unregulated nature of over-the-counter trading, and it is easy to see why things ran amok.

London and the LME will not be let off quite so easily, however. It is no good saying: "But it's the same everywhere else". Nymex, the LME's American rival in New York, thinks it isn't in any case. Nymex believes the reason London is so successful in attracting business and traders is precisely because it is so under-regulated. Nymex said so publicly only days before the balloon went up at Sumitomo, another piece of prescience the LME would rather ignore. This is an interesting reversal of the usual argument that high standards of regulation attract business and low standards drive it away. Not in the wholesale markets clearly, where the looser the regulation, the more the professionals seem to like it.

It would be wrong to blame the whole thing on the incompetence of the LME, even if this antiquated institution does represent the unreconstructed face of the old City. There are plenty of other financial markets where over-the-counter business is booming, not least in equities where a great deal of option activity takes place wholly outside the regulatory net. Because such trading is professional to professional, and because such people can presumably look after themselves, it is thought to be OK. Plainly not, judging by both the Barings (which interestingly was a case of on- market trading) and Sumitomo cases.

Booming over-the-counter business, often in highly complex derivative instruments, makes it that much harder for regulators to track markets and root out potential problems. The main failure in the Sumitomo affair was the bank itself, which lacked the internal controls to halt its powerful rogue trader. The regulatory failure in London, if that is indeed what occurred in a playground meant for big boys only, is a secondary aspect of the affair. As for claiming credit for uncovering the whole charade, the Securities and Investments Board, which was doing so with abandon on Friday, might be wise to keep its mouth shut. The perceived difference between success and failure in regulatory affairs is a slim one. Feted today, the SIB could find its role exposed as an altogether less flattering one tomorrow.

Sainsbury's copies to catch up

Poor old Sainsbury's. These days it seems to be forever catching up. Just copying others, is not going to do the trick though. As every management textbook will tell you, doing the same thing as the competition won't get you anywhere. Sainsbury's reward card, launched yesterday, may have the added attraction of air miles plus other unspecified goodies to come, but it is in other respects pretty similar to the Tesco loyalty card. As such it might succeed in halting the slide in market share but it won't, of itself, reverse it.

The Sainsbury's reward card even offers exactly the same effective 1 per cent payback as the Tesco equivalent. You might have thought that in its attempt to leapfrog rivals, Sainsbury's would have been a little more ambitious. But herein lies the nature of Sainsbury's problem. Fundamentally and culturally, it doesn't like all this price discounting lark. Unfortunately, in an age where supermarket quality is judged much of a muchness, discounting is where it counts.

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