There are three futures market which was occupied in Leeson's trading activities. There are Futures on the Japanese Nikkei 255 stock index, futures on 10 year Japanese Government bonds (JGB futures) and Euroyen futures. These products are traded and alike design on SIMEX and on a Japanese exchange. Leeson's main assignment was to arbitrage between SIMEX and the exchange in Japan and try to capitalize on low price differences between the futures contracts. Leeson was taking huge uncertain positions, financing SIMEX margin requirements by selling options and borrowing huge amounts of money from Barings's head office in London. By the end of February 1995, the losses had become too large and Barings bank went bankrupt.
Base on our research, the doubling strategies are potentially high risk from a systemic point of view which was Mr Leeson using it. The most important attribute of doubling strategies is that the inevitable and devastating loss is proceeding by a period if high return with low volatility. This doubling strategy was taking high risk.
On July 1992, Barings Futures Singapore started trading on the Singapore International Monetary Exchange (SIMEX). Mr. Leeson was putting in charge of operations for Barings futures Singapore, with responsibilities for both trading and the accounting and settlements activities. Barings Futures Singapore believed that was unnecessary to segregate these functions because Leeson and his staff would merely execute orders placed by other Baring Group companies on behalf of their external clients (SR 3.1,5.15). Later in 1992 this situation is changed, because many of Japanese institutional investors had set up their own execution capability in Singapore. We know that BSJ traders ask Leeson to execute Nikkei Futures trades on SIMEX (SR 2.11) and the trading volume handled by Leeson was increased time by time in early 1993. Besides, Leeson was involved in executing proprietary trades as well as trades for the external clients of the Barings Group.
Leeson would play a major role for example arbitrage trading if the Nikkei futures contract between SIMEX and the OSE (Osaka Securities Exchange). We know there are existed larger price difference between the two contracts that were similar in design. The profit from exploiting like price differences between exchanges are small and therefore trading volumes tend to be large but the risk still low. Leeson also developed lucrative activity and name it as "switching". When the Barings able to trade in Japan as well as in Singapore, it could select the cheapest market to execute a client's order. For the result, these activities was that the Structured Products Group, which includes Leeson's activities , showed an operating profit over 1994 which was five times what had been planned for that year.
On July 3 1992, only two days after Barings was granted membership by SIMEX, Leeson opened Account 88888 and that same day, the first transaction was booked in this account ( SR 3.13). On BFS's (Barings Futures Singapore) system, this account described as an error account. It is common for traders to set up such an account for the purpose of netting minor mistakes but the net position should be closed each day and net value of gain and losses incurred in negating the position should be recorded as part of unit's daily profit (Leeson,1996, p38-39). During the first month of its existence, a huge number of transactions were booked in Account 88888, which present according to the Singapore report (SR3.13) that it could never have been intended to serve uniquely as an error account. In fact, Leeson gave definitely instructions around July 8, 1992, to change the software to exclude Account 88888 from all market activity reports and the information was one and only used for the estimation of SIMEX's margin. In other words, the steps taken by Leeson in the first days of responsibility for activities of BFS, were to ensure that his actions would not be transparent.
During 1993, the focus of Leeson's unauthorized speculative positions in Account 88888 was the generation of profits in the normal trading accounts of BSL, and BSJ for the client or proprietary traders. This enabled Leeson to achieve a reputation as a star trader on SIMEX and enhanced his intrafirm executive standing. However, by the end of 1993 the cumulative losses in Account 88888 were over ¥4 billion (about US$35.8 million) which made the situation much more intricacy. Leeson's main problem became the management of the flow of funds to support the margin calls from SIMEX.
An important way to plan the funding was by manipulating the trading and accounting records. This was done in a number of ways. First, some transaction booked in Account 88888 was initially booked in the accounts of BSJ and BSL. If these situations had been correctly reported to BSJ and BSL, it would have been clear that risk limits had been exceeded since such transactions were not hedged. However, Leeson would execute offsetting trades about thirty seconds before market close. Nick Leeson trying place transactions from BSL or BSJ accounts into Account 88888. This called "transfer trade", Leeson avoided reveal of unhedged position in the reports to BSJ and BSL ( SR3.21). The price of these transfer trades were later adjusted to favor BSL or BSJ, at the expense of Account 88888,in order to confirm his reputation as an exceptional trader. A second way to handle the records was to record fictitious trades between the account of BSL and BSJ and Account 88888 in the BFS daily list of transactions, when no transfer trades had been executed. The effect was that unhedged condition were transferred from BSJ or BSL accounts to Account 88888, so that no unhedged condition were reported at the end of the day (SR 3.31). At last, Leeson often instructed his settlements staff to record fictitious trades in the accounting system. These fictitious trades reversed at the opening of market on the following day. The aim was to reduce end-of-day open positions in Nikkei and JGB futures in BFS's accounting records and consequently in the SIMEX computer system. This practice effectively decreased margin calls from SIMEX (SR3.37)
Despite the manipulations of the books, the funds needed for SIMEX's calls steadily boosted. Leeson used a number of methods to convince BSL management of the necessity to transfer huge amount of money to Singapore. First, he explained that the profits from individual arbitrage transactions are small and therefore trading volumes should be huge. Since both exchanges related in the transaction require separate margins to be deposited, huge amounts of money are needed. Second, Leeson claimed that SIMEX demanded so-called "advance margin calls" (SR 3.42). Besides, these advance margin calls were intra-day margin requirements imposed by SIMEX because of volatility in the trading prices of the suitable contracts (SR3.43). Leeson convinced BSL that it was hard to gain same day payment from the ultimate client due to differences in time zones. Therefore, BSL had to finance these requirements and funds transferred from London. Leeson sold options on Nikkei index through Account 88888 from the start of 1993. From January 1994, the position in Nikkei options grew significantly when Leeson set up at huge series of short straddle position.
The largest part of Barings' losses came from a massive long position in Nikkei futures. Until October 1993, Leeson's losses always recovered. After that, losses keep growing, but accelerated in the final two month leading up to the collapse of Barings. During the final stage, Leeson expanded his long position in Nikkei futures to 49% of the open interest in the March 1995 contract and 24% in the June 1995 contract. The total of monthly trading volume through Account 88888 increased from 2051 in July 1992 to a peak of 96121 in September 1994. In January 1995, the total was 90000 contracts (SR3.14) or about 7.5% of total trading volume.
There had been a same growth in the trading of JGB futures. By November 1994, the volume of JGB futures transacted through Account 88888 represented 24% of the total volume of SIMEX (SR3.19). The volume of Leeson's unhedged JGB condition in the 88888 account also grow, in particular during the two months leading up to Barings' collapse. Eventually, his short position was over 28,000 contracts. Leeson started to trade Euroyen futures through the 88888 account in October 1993, but after that month, his transactions in this market were limited to certain short time intervals only. The eventual loss on these Euroyen positions was only £3 million. However, Leeson first sold options on the Nikkei index in October 1992, but his activity in this market really started in the second half of 1993. The value of the option portfolio vacillates wildly over time, but it had mostly been positive. The highest value achieved by the end of December 1994, when the total value of the options was approximately US$178 million. Mostly due to the Kobe Earthquake, this reversed to a loss of approximately US$108 million by the end of February 1995 (SR App.3K.p.179) . On February 23 1995, Barings was not able to meet its margin requirements on SIMEX. The total loss accumulated by Leeson was US$1.4 billion.
In the case of Leeson, paint a vivid picture of a person who seeks to become the master of the universe managing to gain a reputation as a star performer. Leeson tried at all cost not to lose that image. When losses were mounting, he obeys a strategy of continuously expanding his position, a quote from Leeson (1996) "I felt no elation at this success. I was determined to win back the losses. As the spring wore on, I traded harder and harder, risking more and more. I was well down, but increasingly sure that my doubling up and doubling up would pay off… I redoubled my exposure. The risk was that the market could crumble down, but on this occasion, it carried on upward… As the market soared in July [1993], my position translated from a £6 million loss back into glorious profit.
Data
For Nikkei futures and options traded on the OSE, we also have transaction date for the period from July 1, 1994, which is 6 months before the Kobe earthquake, until July 1 1995, which is 4 month after the bankruptcy of Barings. Leeson gradually become a dominant player on the Nikkei futures market in Singapore and he believed his own actions had price impact. Therefore, a first step is to see whether his trades actually influenced prices during the months leading up to Barings' collapse. His make a transaction on SIMEX may have led to structural price differences between the OSE and SIMEX.
Period
Start
end
1
July 1, 1994
Oct 31, 1994
Base period
2
Nov 1, 1994
Jan 16, 1995
Heavy trading by leeson
3
Jan 17, 1995
Feb 23, 1995
Between earth quake and Leeson's departure
4
Feb 24, 1995
Mar 10, 1995
Period of uncertainty until ING takes over all liabilities
5
Mar 11, 1995
July 1, 1995
Stabilization
During the period 1, one would not expect a significant price difference, since no major events took place and arbitrage would probably look after of price differentials instantly . In period 2, Leeson purchases huge amounts of futures on SIMEX, trying to push up prices. His action may have caused price differentials to be more persistent. During period 3, the market became more volatile and price differentials may have persisted for a longer period. Leeson stepped up his purchases on SIMEX. Period 4 covers the internal during which SIMEX experienced the huge threats. If traders were concerned about the health of the exchange, one would expect them to be prepared to pay a premium to hold Osaka futures. Ito and Lin (1996) find some evidence for an increased systemic threat during this period. Finally, period 5 would be a period of stabilization, returning to a normal market.
Leeson and SIMEX Nikkei Futures
This table shows the result of the T-test. The price difference calculated as the price on OSE minus the price on SIMEX.
Net Investment and cumulated trading profit from 26 January 1995
Net position as a function of trading result
During the final month at Barings, Leeson was betting on rising Japanese shares prices and interest rates. He built up large positions on both the Nikkei and the JGB futures market. In the net investment and cumulated trading profit diagram provided an indication that there is a relationship. Cumulating the positions and trading gain or losses from January 26, 1995 we find that net long positions increased exponentially as trading losses mounted up to the point where Leeon departed Barings Futures( Singapore). Net position as a function of trading result diagram show the net long position was an increasing function of the net trading losses and that the only time there were any sales were on net gains relative to the positions as of January 26, 1995. This negative relationship between position and trading result is important at the 1% level.
