Barings Bank established in 1762 was one of the oldest merchant banks in Britain until its collapse in 1995. The official banker to the Queen, Barings Bank has been a pivotal part of world history funding the Nepoleanic wars, purchase of Alaska by US from Russia, The trade agreements with South America and many import trade agreements as part of the East India Company (D). In 1880s the bank ran into some trouble regarding Argentina's loans which were said to have defaulted to the tune of 21 million pounds post which the bank was not allowed to partake of any major financial decisions, which led the bank to offer financial service and consulting to wealthy clients. In the 1950s the bank was elected by Her Majesty as one of the guardians of the royal fortune (B). Towards the late 1980s and early 90s the bank became aggressive in re-entering international finance, getting into the brokerage business and consulting on merger and acquisitions outside Britain. The Barings Future group was set-up which looked into brokerage and trading facilities provided by the bank. Since 1987, the bank maintained an office in Singapore called Barings Security Singapore limited (BSS) which focused on equity, but time saw the volumes of futures being traded on the SIMEX increase. BSS had to pay large commissions as they themselves did not have a trading seat on the exchange. In an expansion frame of mind Barings needed to employ traders and purchase a seat on the exchange and to head this operation they were looking for someone.
In came Nick Leeson, whose recent success in the Jakarta operations where he converted about 100 million pounds worth of bearer bonds and certificates deliverable had made him well known with the management at Barings (A). In 1992 Leeson was made head of General Manager and was allowed to employee back office staff and traders. Soon Leeson acquired a trading license, making him head trader, general manager and in charge of the back office operations. Nick was involved in derivatives trading and hedged long and short term positions on the Singapore and Japanese exchanges. In February of 1995, Leeson has lost $1.4 bn on derivatives trading while the bank's reported capital was only about $600 m (Fay, 2006). These losses were hidden in account '88888' which was initially created to cover the loss made by one of his traders of the amount of 20,000 pounds, but later Leeson undertook cross trading activities and used the same account to conceal his losses. Leeson entered into a significant volume of cross transactions between account '88888' and account '92000' (Barings Securities Japan - Nikkei and JGB Arbitrage), account '98007' (Barings London - JGB Arbitrage) and account '98008' (Barings London - Euroyen Arbitrage). Table 1 illustrates the values for various futures as actuals vs. declared by Leeson while reporting back to management in London.
Table 1
Fantasy versus Fact: Leeson's Positions as at End February 1995.
Number of contracts1
nominal value in US$ amounts
Actual position in terms of open interest of relevant contract2
Reported3
Actual4
Futures
Nikkei 225
30112
$2809 million
long 61039
$7000 million
49% of March 1995 contract and 24% of June 1995 contract.
JGB
15940
$8980 million
short 28034
$19650 million
85% of March 1995 contract and 88% of June 1995 contract.
Euroyen
601
$26.5 million
short 6845
$350 million
5% of June 1995 contract, 1% of September 1995 contract and 1% of December 1995 contract.
Options
Nikkei 225
Nil
37925 calls
$3580 million
32967 puts
$3100 million
1. Expressed in terms of SIMEX contract sizes which are half the size of those of the OSE and the TSE. For Euroyen, SIMEX and TIFFE contracts are of similar size.
2. Open interest figures for each contract month of each listed contract. For the Nikkei 225, JGB and Euroyen contracts, the contract months are March, June, September and December.
3. Leeson's reported futures positions were supposedly matched because they were part of Barings' switching activity, i.e. the number of contracts on either the Osaka Stock Exchange, the Singapore International Monetary Exchange or the Tokyo Stock Exchange.
4. The actual positions refer to those unauthorized trades held in error account '8888'.
Source: The Report of the Board of Banking Supervision Inquiry into the Circumstances of the Collapse of Barings, Ordered by the House of Commons, Her Majesty's Stationery Office, 1995
Once the cross-trades were carried out, Leeson would ask the settlements staff to break down the total number of contracts into several different trades. The trade prices were then changed and profits were credited to 'switching' accounts and losses were charged to account '88888' (C). Hence, for a long time Leeson was able to fool the management by showing profits for BSS and evaded declaration of the huge losses he was amounting.
Leeson continued to bet that the Japanese stock exchange would rise, but it plummeted after the Kobe earthquake of January 17, 1995. Leeson's positions went in the opposite direction to the Nikkei - as the Japanese stock market fell (E). The Barings Bank filed for insolvency in 1995 as it could not meet the enormous trade obligations established by Leeson. The impact on affected parties was huge as 25,000 employees of Barings around the world did not receive their bonuses and In June 1995 Barings was taken over by one of the largest Dutch financial services companies, ING for a first sale price of just $1bn. 21 of the top officials at Barings were fired. Leeson was arrested and sentenced to 6 years in the Changi Prison in Singapore from where he was release in 1999.
Q 2 Use the agency theory framework to identify the main reasons the company had failed its shareholders and stakeholders.
The Agency theory framework suggests that there is a basic conflict of interest between the individual serving a firm and the firm serving a shareholder(textbook). This conflict of interest in an imperfect market situation gives rise to unethical behaviours and corporate mishaps endangering the interest so of the principals (shareholders) by the agents (firm managers) (Eisenhardt, 1989). Barings underwent a major re-organisation in 1993and the bank's management, undergoing disturbance in London. The Risk management function was just being introduced and was not traditionally present. The lines of control and reporting were not clearly established as a matrix-like structure was adopted where there were two kinds of reporting channels, products based and operations based. (Barings Scandal, 1996). Also, BSS was recording profits and hence money flowed there from London without too much concern or control.
Leeson was both, Head of trading and Head of settlements. Traditionally as head of trading he would be reporting to head of settlements who should have been another person, but the absence of this structure suggests lack of audit and risk control mechanisms. Leeson could trade however he wanted and (fudge) cock the books to reflect desired results (Ross, 1997). Agency theory emphasises on two things, an information mechanism like the board of directors and a risk management/ evaluation control mechanism (Eisenhardt, 1989) both of which were absent at Barings. Senior management involvement was almost absent and Leeson was given a freehand for operating the way he saw fit only because he was recording profits which highlights the agency theory principle that self interest is different from maximizing an organisation's value and therefore shareholder wealth. Leeson was acting to make a personal fortune neglecting all his duties towards the stakeholders or shareholders (Schachler, Juleff , & Paton, 2007).
Lack of official reporting relationships, lack of separation of Leeson's duties, lack of differentiation of amounts for client trading and house trading, lack of sufficient balance in the firm's balance sheet, unrealistic profit expectations of managers by senior management (Greener, 2006), tendency to take extraordinary risks in lieu of graining extraordinary benefits by generating high profits, circumventing the computerized financial reporting system by Leeson and negligence on the part of internal and external audit agencies form the reasons for the Barings collapse of 1995.
Maybe in dot points?
Q3 In hindsight, what measures could have been instituted to prevent the collapse of the company you have chosen to profile?
The biggest hole in the governance strategy of Barings Bank about their Singapore operations was the concentration of front office and back office controls with one person, Nick Leeson. This diluted any financial, risk and/or ethical controls of the operations and the individual Leeson (Drennan, 2004). Had a formal reporting structure been in place and the management more stringent and involved in deciding monetary trading caps for Leeson, they might have become aware of the disastrous 88888 account in time to save the bank's collapse.
Also, maintaining enough capital in the organizations' books to withstand adverse market changes could have helped Barings, but Barings' senior managers continued to fund Leeson's activities because they thought they were paying margins on hedged positions whereas in reality they were losing money on outright bets on the Tokyo stock market. Presence of poor market, credit and funding control procedures also let to Leeson manipulating the situation to his advantage as there were no limits set on trading activities by senior management (Greener, 2006).
Hence, separation of Leeson's responsibilities, a more responsible reporting structure, stringent financial trading controls, and absence of ego-defensiveness (Why your organisation could be the next Barings Bank, 2002) and therefore investigating into the jarring mistakes of Leeson are some of the measures that could have flagged off warning signs at least.
Lenient auditing from internal and external agencies alike that are either part of in on the scam or just too afraid to lose a big client was also one of the reasons for the Barings Bank collapse. Also the lack of knowledge of non-banking businesses for banks when they venture into such ventures is also one of the reasons that causes negligence and teething problems, causing some high flying executives to search for their moment of glory in these situations.
Q 4 There has been significant effort in the past 10 years to develop a framework for corporate accountability. Provide a summary of these efforts, and explain how such changes could help change the landscape of corporate governance.
The Board of Banking supervisions conducted an inquiry on the Barings collapse and came up with plausible causes of the debacle and who were the entities to blame. Top and senior management, excessive bonuses to be won by high performers (Drennan, 2004), and a cut-throat competitive, plus the pressure to succeed in a new business were some of the cause as they have been enumerated in detail throughout this paper. These concerns have lead to increased focus on changes in corporate setup, formation and control of boards and the role of risk and audit functions. The collapse of Barings Banks was the single most import event in business history that has shaped many of the regulatory frameworks today. These include regulatory consolidation, reduced risk of collapse, improved communication between lines of authorities, and the creation of the Financial Services Authority that brought 9 different regulators under one roof. (Rae, 2005). The Department of Trade and Treasury has laid down conditional stipulations against CEO remunerations and distribution of obscene amounts of bonuses. The Company's Bill looks to solidify Directors roles and responsibilities and give more control to the board rather than to the individuals (Drennan, 2004). The Securities Commission has also laid down certain revised rules for derivatives trading making the caps for client and house trading compulsory for trading firms.
Hence the landscape of corporate governance has become more stringent and starker where fudging is no longer as easy as it seemed and hiding large sums of money in concealed accounts no longer an invisible trick to pull. Naïve management and clever rogue traders like Leeson may have had their tryst with fame and tragedy alike, but the business landscape in their wake is a more controlled and responsible environment. ????? financial crisis a few years later shows that it is still happening…..
