1. Introduction
The event is about the collapse of the Barings Bank. This story is all about how a man broke Barings Bank. The story starts when Nick Leeson arrived Singapore in 1992, he was allowed to take positions only if they were arbitrage opportunities between Singapore International Monetary Exchange (SIMEX) and Osaka Stock Exchange (OSE) in Japan. Leeson's Singapore office is terribly understaffed, so his team created a lot of trading errors.
Everything began with an error account "88888". This account was created by a new phone clerk who made a loss of 20,000 pounds with this mistake. Since Leeson tried to cover up this and other losses from his team, he began his unauthorized trading from that day. With the error account, he secretly sell options and took positions on SIMEX on both futures and options contracts. People in London thought he was a smart trader who created half of Barings Singapore's 1993 and 1994 profits. But in fact, in 1994, Leeson lost Barings $296 million while his boss in London thought he made them $46 million. He did all that with the technique of the *cross-trade. Leeson used the error account "88888" he created and another real account "92000" for the cross transactions. He changed the trade prices to cause profits to be credited to account "92000" while the losses were charged to account "88888". In this case, what everybody saw was his successful account "92000".
In November and December 1994, without the permission from Barings London, he made premium income by selling 34,000 options as *straddles. In December 1994 and January 1995, Nikkei was trading in a range of 19,000 and 19,500, and Leeson was holding long futures positions of Nikkei 225 equity contracts on the OSE. In Leeson's case, he needs the Nikkei to be traded within or near strikes between 18,500 and 20,000. The Nikkei dropped significantly after the Kobe earthquake on January 17th as people took money out from the market. There was a bounce two weeks after the crisis, and Leeson hoped for a strong short-term v-shaped rebound.
By using his error account, Leeson launched an aggressive buying program, which summed up to 55,000 March 1995 contracts and 5,000 June 1995 contracts. Unfortunately, it was a bull trap. The market dropped further in February. In the end, Barings collapsed as it couldn't meet the huge trading obligations for the positions that Leeson established. As a whole, on February 27th , 1995, Barings had outstanding notional futures positions on Japanese equities and interest rates of $2 billion, including $7 billion on Nikkei 225 equity contracts and $20 billion on Japanese government bond and European contracts.
A *cross-trade is a transaction executed on the floor of an Exchange by only a member who is both buyer and seller. If a member finds matching buy and sell orders from two different customer accounts for the same contract and at the same price, he will be allowed to cross the transaction and execute the deal by matching both clients' accounts.
*Straddles is put and call options with the same strikes and maturities. This option strategy is quite profitable if the Nikkei 225 is trading at the options' strikes on expiration date since both puts and calls will expire worthless. It can still be profitable if the Nikkei is trading near the options' strike on expiration date because the premium can offset the loss from calls or puts.
1.2 Important of the topic to a financial student
This topic is very important to the financial student. The story of Nick Leeson is a good lesson for financial student. From the incident like Leeson, student can learn more on the ethical issues. Nick Leeson, who lost US$1.3 billion during his 41-year-old in 1995 at Barings but only spent less than five years in prison. He is now able to earn about US$12,000 for a 30-minute speech according to rumour. After come out from jail, self deprecating, Leeson feel guilty as charged for hiding trading losses at one of England's oldest merchant banks, Barings Bank. He is aware of his mistake. He told to the media that from the beginning what he was doing was wrong.
However, to be fair, Leeson didn't intend to be a criminal. He was growing up in a working-class family. His family was poor and he started working after his A-levels. His first job was as a bank clerk before working his way up the corporate ladder to be the kind of model employee Barings was looking for to manage its Singapore business and oversee its futures markets operations. However, Leeson had never received any right kind of training to take on such a task. To get survive in a bad situation, he floundered and hid his accumulating losses from his boss. He didn't intend to defraud anyone, but he had no choice. He didn't want to be a failure and asking for help at Barings because it is a sign of weakness. His lack of knowledge results error in judgment.
Raising ethical issues is very important as everyone includes employees and employers will face ethical problems at work. The director of the Ivey School of Business MBA program, Tony Frost agrees that even though it was an unusual approach to have a convicted criminal like Nick Leeson to speak about ethics, however there was something to learn, especially for the financial students and young teenagers today. After all, Leeson is a man who had made poor decisions, admitted his responsibility and could now take a step back and give his perspective to other people. Financial students should be learning more from this topic on the ethical issues as they are the future leaders. Nowadays, ethical dilemma is very common at work. Most people in an organization will face ethical dilemmas in an organization. Conflicts are always easy to occur when an organization has people who are diverse in nationality, sex, race, religion, age, education, socioeconomic status and employment experience. The most common ethical dilemmas at work include power, authority, confidentiality, honesty and loyalty. First of all, students can learn to be more honesty and loyalty. Being honest and loyalty is very important as it can affect a person and even the whole organization's reputation. A good image or reputation will lead more people and customer to trust the organization and attract them to corporate with the organization. Everyone knows what is right and wrong. Students should also know that the act of hiding losses from boss like Leeson is totally an unethical behavior in workplace. He should not did it even though he did not want to ask for help at Barings because this is a kind of cheat and defraud. Therefore, his act caused a 200-year-old bank, Barings to collapse in the year of 1995 as it couldn't meet the huge trading obligations. He was then being caught and jailed for what he did. After come out from jail, he was the most unemployed person in the world as no one will trust and hire him anymore. From this case, we can see that how important is the values of being honest and loyalty.
Next, students can also learn from Nick Leeson on his act of feeling guilty after did something wrong. He admitted his responsibility. From the beginning, he knew what he was doing was wrong. He knew his mistake and his act of being remorse and reformed is laudable. Students or young teenagers nowadays should learn this spirit from him. Now, Leeson is trying hard to do his best to contribute to the public. He become one of the world's most *sought-after speakers. He is now available for after-dinner-speaking, where he talks about the collapse of Barings, his time in prison and his fight against cancer. Besides, he is also the CEO of Irish soccer team Galway United FC, author of two books, and had hot Scottish actor Ewan McGregor star in the movie of his life, *Rogue Trader. It is not a bad career for a reformed criminal.
Moreover, Leeson also has the courage to undertake on the aftermath that will come to him. After come out from jail, he found no job and suffered discrimination from others. In addition, his wife, Lisa divorced him and he was diagnosed colon cancer during he was in the jail. However, Leeson did not even thought of give up himself even though the whole world was giving him up. His persistence and willpower makes his life a great transformation. Finally, he is success and has a great new life again. This kind of spirit is very laudable to learn for finance students. Finance students must learn to be persistence and patience as they will face many great deals and problems occur in their workplace in future.
*sought-after means something that is popular, desired and in a high demand. It is generally wanted by a lot of people but rare or difficult to get.
*Rogue Trader is a drama film directed by James Dearden about former derivatives broker Nick Leeson and the 1995 collapse of Barings Bank. It tells the true story of Nick Leeson. Rogue trader however has the meaning of itself. It refers to a trader who acts independently of others - and, typically, recklessly - usually to the detriment of both the clients and the institution that employs him or her. In most cases this type of trading is high risk and can create huge losses.
1.3 Lessons from the topic
From the case of Barings' collapse, it is not only the mistake cause by Nick Leeson. Barings bank itself also has the responsibility. Leeson's bosses didn't see the need to offer him any training. They failed to realize that an employee's past performance is not necessarily an indication of future performance. They should not judge the good performance provided from an employee in past as an indication of future performance. Like most traders, Leeson also need guidance. Besides, Barings also did not question why Leeson was asking for large sums of money in wire transfers, nor did it question what was in the account where he recorded his losses. They should not trust their employee so much. They should always monitor their employees for any of the actions they might take. In addition, organizations should also need a strong set of risk controls, and those in charge need a sophisticated understanding of organizational processes. However, Barings failed to do it because its management failed to institute a proper managerial, financial and operational control system. The firm did not catch on what Leeson was up to. The firm was failed at a number of operational and management levels since the effective controls were weak. There are five main lessons that every organization can learn from the Barings collapse which include, segregation of front and back-office, senior management involvement, adequate capital, poor control procedures, and lack of supervision.
Segregation of front and back-office is important and necessary for every organization. However, Barings did not follow this rule. They let Leeson in charge of both the dealing desk and *back-office. This is equal to allowing a person who works a cash-till to bank in the day's taking without an independent third party checking whether the amount banked it at the end of the day reconciles with the till receipts. Since Leeson in charge of the back-office, he had the final say on payments, ingoing and outgoing confirmations and contracts, reconciliation statements, accounting entries and position reports. As the head of the back-office, Leeson abused his position. He suppressed information on account '88888'. It was an *error account in Barings Futures Singapore system. However, Barings London did not know the existence of this account because Leeson had asked a system consultant to remove error account '88888' from the daily reports. Barings' management makes their first mistake of not segregating Leeson's duties. . An internal auditor's report concluded that his dual responsibility for both the front and back-office was an excessive concentration of powers. The audit team recommended that Leeson be relieved of four duties, which are supervision of the back-office team, cheque-signing, signing-off SIMEX reconciliations and bank reconciliations. However, Leeson never gave up any of these duties even though the regional operations manager South Asia and chief operating officer of Barings Securities Singapore told the internal audit team that Leeson will bring immediate effect cease to perform these functions.
*Back-office records, confirms and settles trades transacted by the front office, reconciles them with details sent by the bank's counterparties and assesses the accuracy of prices used for its internal valuations. It accepts and releases securities and payments for trades. Besides, back office also provides the necessary checks to prevent unauthorized trading and minimize the potential for fraud and embezzlement.
*Error accounts are set up to accommodate trades that cannot be reconciled immediately.
Next, one of the crucial of the Barings' collapse is because of its senior management's lack of interest attitude to the derivative operations in Singapore. Second lessons from Barings collapse is the involvement of senior management. Senior management plays an important role as there is a need for them to understand the risks of the business to help articulate the firm's risk appetite and draft strategies and control procedures needed to achieve these objectives. From this case, we can see that senior managers at Barings are found deficiency in all these areas. For example, while they were happy to enjoy the success of the Singapore branch, they were not so acute on providing adequate resources to ensure a strong risk management system. The senior management's response to the internal auditor's report for a suitably experienced person to run Singapore's back office was that there was not enough work for a full-time treasury and risk manager. There is no senior manager in London checked on whether key internal audit recommendations on the Singapore back office had been followed up. Barings' senior management had a very superficial knowledge of derivatives and did not investigate into the area that bringing profits. Management Committee meetings never analysed or assessed properly the profitability of the business. Senior managers did not even know the breakdown of Leeson's reported profits. They mistakenly assumed that most of the switching profit came from Nikkei 225 arbitrage, which actually only generated profits of US$7.36 million for 1994, compared with US$37.5 million for JGB arbitrage. Thus, the ex-chairman of Barings, Peter Baring told the Bobs that he found earnings "pleasantly surprising" since he did not even know the breakdown. The senior management naively took for this business was a goldmine with little risk. The two most senior derivatives staff of Barings, which are the head of the Financial Products Group and Global head of Equity Financial Products together with the bosses of Leeson claim that they thought that the significant and large profits were possible from a competitive advantage that BFS had arising out of its good inter-office communications and its large client order flow. As the *exchanges were open and competitive markets, this means the lack of understanding of the nature of the business and the risks inherent in combining agency and proprietary trading. To meet the *margin demands of SIMEX, Barings had to borrow huge amounts of cash. In this case, senior managers were neglect in their duties as they did not press Leeson for more details of his position and the Credit department for client details. The misplaced belief by the members of the Asset and Liability Committee (ALCO) which thought that the firm's exposure to directional
*Exchanges are an open, organized marketplace, such as a stock exchange, where buyers and sellers negotiate prices. Exchanges require an almost instant or real time bid and ask matching mechanism, settlement and clearing, and market wide price communication and determination.
moves in the Nikkei can be neglect led their management to ignore market concerns about Barings' large positions. When the bank was haemorrhaging cash, London still did not take any steps to investigate the requests for funds in Singapore. This is partly because senior management assumed that a proportion of these funds represented advances to clients. Even then the complacency is still baffling. BFS had only one third-party client of its own - Banque Nationale de Paris in Tokyo. The rest were clients of the London and Tokyo offices. Either London or Tokyo's existing customers had suddenly become very active or Leeson had recently gone out and won some very lucrative accounts or Tokyo or London had a new supersalesman who had brought new business with him. Yet no enquiries were made on this front, which displays a blase attitude about a potentially important source of revenue.
To keep a firm to continue operate, they must have adequate capital. To withstand the impact of adverse market moves on its outstanding positions, an institution must have sufficient capital to keep these positions going. Barings management were willing to fund margin requirements till the contracts expired because they thought that Leeson's positions were market neutral. Therefore, in the end, the collateral calls from SIMEX and OSE proved too much to bear as they were larger than Barings' capital base and this 200-year old institution was forced to call in the receivers. It was funding risk that seriously wounded Barings. The collapse of Barings highlights the need for institutions to pay more attention to the interim funding needs of hedged and semi-hedged positions. Baring's senior managers continued to fund Leeson's activities because they thought they were paying margins on hedged positions whereas they were actually losing money on outright bets on the Tokyo stock market. These incidents state that there is a need for Baring's senior managers to be more knowledgeable about hedged positions because the issues facing them are complex in many cases. As a result, even if Barings managed to borrow enough money to cover its margin costs till the contracts expired, it would also unable to withstand the substantial losses. This is because Barings faced significant market risk from its naked positions. Since the contracts with losses of US$1.4 billion had been closed out by the agents appointed by Barings' administrators, Barings were unable to meet its margin obligations at the end of February. This urged the termination of Barings. Its fate had been come to an end at the end of January when Leeson had an unauthorized Nikkei exposure of about 30,000 contracts.
*margin is collateral that the holder of a financial instrument has to deposit to cover some or all of the credit risk of his counterparty.
Control procedures is the policies and procedures established to provide reasonable assurance of the success of management control. A good quality of control procedures is very important to an institution. The collapse of Barings is cause by poor control procedures. In many trading houses, not only is there a separation of operational duties between the front and back-office, but there is also a unit independent of both to provide an additional layer of checks and balances.
Finally, Barings faced a serious problem of lack of supervision. Leeson had lots of supervisors. However, none of them exercised any control over him. Barings operated a *'matrix' management system, where managers who are based overseas report to local administrators and to a product head. Leeson's Singapore supervisors were James Bax, who was regional manager South Asia, and Simon Jones, who was regional operations manager South Asia. Jones and the heads of the support functions in Singapore also had reporting lines to the Group-wide support functions in London. However, both Bax and Jones told the BoBS inquiry that they did not feel any operationally responsible for Leeson. Bax felt Leeson can directly reported to Baker, his ultimate boss or Walz on trading matters and to Settlements or Treasury in London for back-office matters. Whereas Jones felt his role in BFS was limited only to administrative matter and concentrated on the securities side of Barings' activities in South Asia. Leeson's reporting lines for product profitability are not clear cut since his supervisors were argued on who was directly responsible for him. The global head of equity financial products, Mary Walz, insists that she thought Fernando Gueler, head of equity derivatives proprietary trading in Tokyo was in charge of Leeson's intra-day activities since the latter's switching activities were booked in Tokyo. However, Gueler insists that Baker told him that Leeson would report to London but not Tokyo. He thus assumed that Walz would be in charge of Leeson. Walz herself still disputes this claim however. There are two important incidents which illustrate that Barings was not care towards supervising Leeson. From the first incident, two letters was sent to BFS from SIMEX. In one of these two letters, SIMEX senior vice-president for audit and compliance Yu Chuan Soo complained about a margin deficiency of about US$116 million in account '88888' and that Barings break SIMEX rule 822 which they previously financing the margin requirements of this account. Moreover, SIMEX also noted that the initial margin requirement of this account was in excess of US$342 million. Hence, this caused BFS have to provide a written explanation of the margin difference on account '88888' and of its inability to account for the problem in the absence of Leeson. However, there is no warning lights went off in Singapore. No one investigated who was this customer, why he was having difficulties in meeting margin payments, why he had such a huge position and or the credit risk that Barings will faced if this customer defaulted on the margins that Barings had paid on its behalf. A copy of the letter was not sent to operational heads in London. Simon Jones also did not press Leeson for an explanation. He dealt with the matter by allowing Leeson to draft Barings' response to SIMEX. The second incident caused the attention of London but was again badly dealt. Perhaps all the personnel themselves in Barings were also confuse about what was really happened. At the beginning of February 1995, Coopers & Lybrand brought to the attention of London and Simon Jones on the fact that US$83 million had not been received from Spear, Leeds & Kellogg, which is a US investment group. No one is sure how this multi-million dollar receivable came about. One version of this events is that BFS, through Leeson had traded or broked an over-the-counter deal between Spear, Leeds & Kellogg and BNP, Tokyo. The transaction involved 200 50,000 call options, resulting in a premium of 7.778 billion, which costs US$83 million. The second version was that an 'operational error' had occurred. Both of these versions had very serious control implications for Barings. If Leeson had sold or broked an OTC option, then he had engaged in an unauthorised activity. And if the SLK receivable was an operational error, Barings had to tighten up its back-office procedures.
*'matrix' management is a type of organizational management in which people with similar skills are pooled for work assignments. For example, all engineers may be in one engineering department and report to an engineering manager, but these same engineers may be assigned to different projects and report to a project manager while working on that project. Therefore, each engineer may have to work under several managers to get their job done.
