Heten Koli Paresh Saxena Aditya Malpani

Series 1 – Corporate Governance, SIIB

Barings Bank

Barings Bank (1762 to 1995) was the oldest merchant bank in London until its collapse in 1995.

The demise of the bank was brought about as a result of the actions of a derivative trader, Nicholas Leeson, stationed in Singapore.

This hit came principally from a hit on a long position in the Nikkei 225 futures of notional value around $7bn on the Osaka and Singapore Exchange.

One may however ask: How is it possible that this one man

was able to cripple a financial giant?

What was the role of senior management in this situation and did they contribute to the demise?

How effective were the internal control systems and was the Singapore operations managed effectively?

How certain deficiencies in internal controls and risk management systems impacted the bank and ultimately led to its collapse.

Nicholas Leeson – The Rogue Trader

Worked for Morgan Stanley after graduating university. Hired as a relatively young clerk, he went to Barings' Singapore office in

1992. He was put in charge of operations for Barings Futures Singapore (BFS),

with responsibilities both for trading and the accounting and settlement activities.

These functions were not segregated because Leeson & his staff were expected to merely execute orders placed by other Barings Group companies on behalf of their external clients.

Later in 1992 many Japanese institutional investors set up their own execution capability in Singapore. As a result, the external client business of Baring Securities Japan (BSJ) became less viable.

To compensate for the loss of business, BSJ commenced proprietary trading on behalf of the Barings Group.

Leeson alone made about 10 million Pounds that year, which was about 10% of the bank profits of that year.

Leeson’s Doubling Strategy An attribute of doubling strategy is that the inevitable &

devastating loss is preceded by a period of high returns with low volatility.

Leeson’s trading activities mainly involved three futures market:• Futures on the Nikkei 225 stock index

• Futures on 10-year Japanese Government bonds

• Euroyen futures

Leeson’s main assignment was to arbitrage between SIMEX and Japanese exchanges in the futures contracts.

Instead of arbitraging, he was speculating, financing SIMEX’s margin requirements by selling options & borrowing huge amounts of money from Baring’s head office in London.

The Collapse Nicholas bought a substantial number of contracts, 11,000 on the

20th of January 1995, just three days after the earthquake in Kobe.

Probably, he thought that the market had overreacted and that thefall of the Nikkei 225 from 20,000 to 18,950 was only temporary.

But the Nikkei 225 dropped even further and by Monday 23rd 1995, the Nikkei 225 was around 17,950. At the end of February 1995, Nicholas Leeson had leveraged his position to $7bn, holding about 61,000 contracts.

The margin calls were enormous and Barings Tokyo London had to transfer urgently a massive $835 m to Barings Singapore in January and February to cover the margin calls on Simex. These calls made finally Barings bankrupt as its reported capital was only of $635m.

Leeson: Then He was then extradited back to Singapore where he received a 6 and

a half year sentence to jail. Barings creditors went legal proceedings. Many executives who were involved in the failure to control Leeson either resigned or were sacked.

In July 1999, Nicholas Leeson was released from jail on the ground of good behavior.

Ruined, abandoned by his wife and sick with a cancer (detected while in prison), Nicholas Leeson became quite popular as the symbol of the rogue trader

Specific lessons have been learnt but loopholes appear all the time

Raised the standards of internal controls and compliance.

Banks are better capitalized which makes them less likely to collapse in case of future rogue trader strikes.

Front and back office operations are carried out independently from each other.

Although lessons have been learnt there are loopholes. The market is always changing in terms of products , complexity, and vulnerability to fraud within and supervision from outside.

Could the regulators have done more?

Most of the banks are of the opinion that regulators should not me blamed for the rouge trader incidents.

The regulators cannot stop rogue traders from trying to fool banks internal control.

Others suggested of having minimum risk management standards for every branch irrespective of its size and volume

None of the regulatory authorities in Singapore, Japan and UK discovered the true use of error account.

SIMEX assumed that Barings was hedging and not speculating when it granted an exemption on the number of contracts that Barings could hold. In addition, the speculative position of Barings was hidden due to use of an omnibus account to clear trades. With an omnibus account, the identity of the broker’s account is hidden from the exchange and clearing house.