Case Study Barings
Summary: One of the most infamous tales of financial demise is that of Barings Bank. Trader Nick Leeson was supposed to be exploiting low-risk arbitrage opportunities that would leverage price low rage differences in similar equity derivatives on the Singapore Money Exchange (Simex) and the Osaka exchange. In fact, he was taking much riskier positions by buying and selling different amounts of the contracts on the two exchanges or buying and selling contracts of different types.
Thanks to the lax attitude of senior management, Leeson was given control over both the trading and back office functions. As Leeson’s losses mounted, he increased his bets. However, after an earthquake in Japan after caused the Nikkei Index to drop sharply, the losses increased rapidly, with Leeson’s positions going more than $1 billion into the red. This was too much for the bank to sustain; in March of 1995, it was purchased by the Dutch b bank ING for just one pound sterling.
Overview: Barings Bank had a long history of success and was much respected as the UK’s oldest d merchant bank. But in February of 1995, this highly regarded bank, with $900 million in capital, was bankrupted by $1 billion of unauthorised trading losses. In 1993, Nick Leeson was appointed general manager of the bank’s Barings Futures subsidiary appointed in Singapore. In this capacity, he was able to conceal his unauthorised trading activities for over a year because he managed both the trading and back office functions.
The senior managers at a Barings came primarily from a merchant banking background and knew very little about trading. Even in the face of large profits, which should have tipped management off to the fact that substantial risks were being taken, they continued to believe that Leeson held matched Leeson positions on the Singapore International Monetary Exchange (Simex) and the Osaka exchange, and hence was making a low-risk profit. low In fact, Leeson was trading derivatives contracts on the two exchanges that were, in some cases, of different types and, in some cases, in mismatched amounts.
For example, Leeson rent executed a trading strategy known as a “straddle,” with the objective of making a profit by selling put and call options on the same underlying financial instrument, in this case, the Nikkei th 225 Index. A straddle will generally produce positive earnings when markets are stable but can result in large losses if markets are volatile. Leeson created an error account numbered 88888 as a holding area for any premiums or losses that he made. Leeson claims that he initially opened the account to conceal a single loss of e. 0,000 pounds sterling that had resulted from an accounting error until he could make up the difference through trading. However, he continued booking various losses into the account and also continued to increase his volume of trading and level of risk taking. Leeson took unauthorized speculative positions primarily in futures linked to the Nikkei 225 and Japanese government bonds (JGB) as well as options on the Nikkei. He hid his trading in an unused BSS error account, number 88888. Exactly why Leeson was speculating is unclear.
He claims that he originally used the 88888 account to hide some embarrassing losses resulting from mistakes made by his traders. However, Leeson started actively trading in the 88888 account almost as soon as he arrived in Singapore. The sheer volume of his trading suggests a simple desire to speculate. He lost money from the beginning. Increasing his bets only made him lose more money. By the end of 1992, the 88888 account was under water by about GBP 2 million. A year later, this had mushroomed to GBP 23 million.
By the end of 1994, Leeson’s 88888 account had lost a total of GBP 208 million. Barings management remained blithely unaware. On February 23, 1995, Nick Leeson hopped on a plane to Kuala Lumpur leaving behind a GBP 827 million hole in the Barings balance sheet. As a trader, Leeson had extremely bad luck. By mid February 1995, he had accumulated an enormous position—half the open interest in the Nikkei future and 85% of the open interest in the JGB future. The market was aware of this and probably traded against him.
Prior to 1995, however, he just made consistently bad bets. The fact that he was so unlucky shouldn’t be too much of a surprise. If he hadn’t been so misfortunate, we probably wouldn’t have ever heard of him. Traders sometimes speculate without authorization. Presumably, a few are able to cover their tracks. Others are caught. When they are caught, they are fired, and their employer eats the loss. Usually, neither the trader nor his employer has any interest in publicizing the incident. Leeson made headlines precisely because he was so unlucky.
By the time he was discovered, he had bankrupted his employer. Publicity was unavoidable. What is amazing about Leeson’s activities is the fact that he was able to accumulate such staggering losses without Barings’ management noticing. As Leeson lost money, he had to pay those losses to SIMEX in the form of margin. Leeson needed cash. By falsifying accounts and making various misrepresentations, he was able to secure funding from various companies within the Barings organization and from client accounts.
His misrepresentations were flimsy at best. For example, he claimed that he needed funds to make margin payments on behalf of BSS clients, and he gave a technical argument related to how the SIMEX collected margin as justification. This claim was false. It was actually against SIMEX rules for a broker to post its own money as margin for a client. Even if the claim were true, the funds would have been needed only temporarily—until the client could make payment. Instead, Leeson continued to ask for ever more funding.
Leeson increased the size of his open positions even as his losses increased due to volatility in the markets. When an earthquake in Japan caused a steep drop in the Nikkei 225 equity index , however, Leeson’s unauthorised trading positions suffered huge losses and his operation unravelled. On March 3, 1995, the Dutch bank ING purchased Barings for 1 pound sterling, providing the final chapter in the story of the 223-year-old bank that had once helped the United States to finance the Louisiana purchase.
The beginning of the end occurred on January 16, 1995, when Leeson placed a short straddle (an options trading strategy) in the Singapore and Tokyo stock exchanges, essentially betting that the Japanese stock market would not move significantly overnight. However, the Kobe earthquake hit early in the morning on January 17, sending Asian markets, and Leeson’s investments, into a tailspin. Leeson attempted to recoup his losses by making a series of increasingly risky new investments, this time betting that the Nikkei Stock Average would make a rapid recovery.
But the recovery failed to materialize, and he succeeded only in digging a deeper hole. Realizing the gravity of the situation, Leeson left a note reading “I’m Sorry” and fled. Losses eventually reached ?827 million ($1. 4 billion at then-prevailing exchange rates), then prevailing twice the bank’s available trading capital. This led to the bank’s collapse. After fleeing to Malaysia, Brunei and finally Germany, Leeson was arrested and extradited back to Singapore on March 2, 1995. While he had authorization for the January 16 short straddle, he was charged with raud for deceiving his superiors about the riskiness of his activities and the scale of his losses, although some observers (and Leeson himself) have place much of the placed blame on the bank’s own deficient internal auditing and risk management practices. Sentenced to six and a half years in jail in Singapore, he was released from prison in 1999, having been diagnosed with colon cancer, which he has survived despite grim forecasts at the time. While in despite prison, in 1996, Leeson published an autobiography, Rogue Trader, detailing his acts.
There may be a temptation to view this debacle as being caused by just one individual – the “rogue trader” – but in reality the fiasco should be attributed to the underlying structure of the firm, and particularly to the lack of internal checks and balances. Events: 1993: Nick Leeson becomes general manager of Barings Futures (Singapore), running the bank’s Simex (Singapore International Monetary Exchange) activities. January 1994: By this date (at the latest), Leeson started selling put and call options on the Nikkei 225 equity index, placing the premiums earned into an error account number 88888.
This strategy, known as a straddle, is essentially a bet on the stability of market prices. 24 February 1994: A memorandum from the Barings’ asset and liability committee values the 4 options portfolio at 2. 8 billion yen. July 1994 – August 1994: James Baker, an internal auditor, spends two weeks in Singapore investigating the immense profits being made there. Baker identifies the weakness of internal controls and recommends that the general manager should no longer be responsible for the back office.
In response, a separate financial manager in Hong Kong is given part part-time responsibility for watching over the back office. ng August 1994: In an attempt to better evaluate its overall risk, Barings sets up an integrated Group Treasury and Risk function, reporting to a new asset and liability committee (Alco). December 1994: A later Barings investigation reveals that, for unknown reasons, Leeson has run up an accrued loss amounting to Y7. 7 billion on the account by the end of 1994. 23 January 1995: The Nikkei 225 drops by 1000 points after an earthquake hits Japan’s industrial heartland. 6 January 1995: The London futures team gives Barings’ Alco Committee a presentation on the Baring Futures (Singapore) operation, which states that Leeson is operating a perfectly perfectl matched book – long in Osaka, but short to the same amount on Simex. 8 February 1995: Coopers & Lybrand decides to hold off signing off on Barings’ accounts until it becomes possible to clear up a few points with Leeson. 23 February 1995: At close of trading, the error account contains 55,399 Nikkei contracts trading, expiring in March and 5640 expiring in June.
As of February 25, this totalled a loss of 59 billion yen on Simex. 24 February 1995: The Barings Board meets to discuss a hastily prepared analysis of the hastily-prepared transactions in Account 88888. March 1995: The Dutch Bank ING agrees to purchase Barings for 1 pound and assume all of its liabilities (Bull, 1995). Lessons to be Learned: Lack of internal checks and balances Even when segregation of duties was suggested by internal audit, the concentration of power in the Leeson’s hands was scarcely diluted. Lack of understanding of the business.
If Barings’ auditors and top management had understood the trading business, they would have realised that it was not possible for Leeson to be making the profits that he was reporting without taking on undue risk, and they might have questioned where the money was coming from. Arbitrage is supposed to be a low risk, and hence low profit, business, so Leeson’s large m. profits should have inspired alarm rather than praise. Given that arbitrage should be cash cashneutral or cash-rich, additional alarms should have gone off as the Bank wired hundreds of rich, millions of dollars to Singapore.
Poor supervision of employees Although Leeson had never held a trading license prior to his arrival in Singapore, there was little oversight of his activities and no individual was directly responsible for monitoring his trading strategies. Lack of a clear reporting line Leeson’s fraud may have been facilitated by the confusion caused by two reporting lines: one to London, for proprietary trading, and another to Tokyo for trading on behalf of customers. customer Allikas: http://www. erisk. com/Learning/CaseStudies/ref_case_barings. asp Kusimused:
1. Millist kauplemisstrateegiat Nick Leeson oma ulemustele teadaolevalt kasutas? Kuidas selle strateegiaga teoreetiliselt raha on voimalik teenida? 2. Millist kauplemisstrateegiat Nick Leeson tegelikult kasutas? Kuidas selle strateegiaga teoreetiliselt raha on voimalik teenida? 3. Mis on back-office funktsioonid? 4. Mis sundmus sai Barings pangale saatuslikuks? Mis selle tulemusel juhtus Leesoni positsioonidega? 5. Mis olid pohjused (mida tehti valesti), et kaesolev Baringsi case sai uldse juhtuda (5 pohjust)? 6. Milliseid eetilisi noudeid Nick Leeson oma tegutsemisega rikkus ning kuidas oleks tulnud korrektselt kaituda?