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 the year of 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 sold options and took positions on SIMEX. 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 34,400 options as *straddles. 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. 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. However, 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 conceptual of 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$24,000 for an hour speech according to rumour. After come out from jail, self deprecating, Leeson feel guilty on his role of causing the collapse of one England's oldest merchant banks, Barings Bank. He was being charged for hiding the trading losses. 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. He was very lucky and got his first job as a bank clerk even though he did not had any financial experience. Then, he worked hard and finally attained the attention of Barings. During that time, Barings was looking model employee to manage and supervise its business and futures markets operations in Singapore. However, Leeson had never received any formal training. He had no experience and was lack of experience in managing the 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 had a strong emulation and did not want to get failure. He did not want to ask for help at Barings because it is a sign of weakness. Hence, his lack of knowledge results the 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 mentioned that even though it was an exceptional way to have a 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 done something wrong, admitted his responsibility and could now stand out and share his perspective to other people. Financial students should get to learn 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 there are difference in nationality, sex, race, religion, age, education, socioeconomic status and employment experience. Power, authority, confidentiality, honesty and loyalty are always the most common ethical dilemmas at work. 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. Financial students should learn that not to cheat and defraud in future during they work as this is a kind of crime.
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. He talks about the collapse of Barings, his time during in prison and his fight against cancer. Besides, he is also the CEO of Irish soccer team Galway United FC. He wrote two books, which are "Rogue Trader" and "Back from the Brink, Coping with Stress". Moreover, his life story also had been come out a movie, named *Rogue Trader which act by the famous Scottish actor Ewan McGregor star.
Moreover, Leeson also has a strong persistence and willpower in mind. He 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. We should not easy to give up no matter what is happened. 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 should realize that an employee's past performance cannot be taken as an indication of future performance. They should not judge the good performance provided from an employee in past will also continue to provide good performance in future. Like most of the traders, Leeson also need guidance. Besides, Barings seems like did not interfered in any act taken by Leeson. They did not suspect or even inquire about why Leeson was asking for large sums of money in wire transfers. They also did not 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, an institution should also need a strong set of risk controls. Those in charge must be proficient in the management of risks and have well understanding of organizational processes. However, Barings failed to do it because its management failed to operate with an appropriate managerial, financial and operational control system. The firm did not keep up with what Leeson was doing. 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. It is the basic operational rule. However, Barings did not follow this rule. They let Leeson in charge of both the dealing desk and *back-office. 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. Leeson abused his position as the head of the back-office. 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 the error account '88888' had been removed from the daily reports by a system consultant, under the instruction of Leeson. Barings' management makes their first mistake of not segregating Leeson's duties. Leeson's was said as having an excessive concentration of powers because he had dual responsibility for both the front and back-office. There are four duties that recommended by audit team that Leeson should be removed of, which are supervision of the back-office, cheque-signing, signing-off SIMEX reconciliations and bank reconciliations. However, Leeson still insisted to continue and never decide to give up any one of these duties.
*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 bring by the business. They need to understand the business risk to help articulate the firm's risk appetite and outline strategies and control procedures to achieve the objectives. From this case, we can see that senior managers at Barings are found deficiency in all these areas. For example, while the Singapore branch was success and they were happy to enjoy it, they were not so acute on providing adequate resources to ensure a strong risk management system. The senior management gave the response to the internal auditor's report that a suitable experienced person to run Singapore's back office was that there was not enough work for a full-time treasury and risk manager. Senior manager in London did not checked on whether key internal audit recommendations on the Singapore back office had been followed up. Barings' senior management just knew little about derivatives. It had a very shallow knowledge of derivatives. They even did not investigate into the area that bringing profits. Management Committee meetings never analysed or assessed properly the profitability of the business. Even the senior managers did not know the error of the profits that reported by Leeson. The senior managers mistakenly assumed that most of the profit came from Nikkei 225 arbitrage generated profits of US$37.5 million. Actually it was only generated US$7.36 million. The senior management naively took for this business was profitable 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 illustrate that nearly half of the profits that generated were possibly from a competitive advantage. It is 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 that there is a 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 focus on the positions of Leeson and the Credit department for client details. The members of the Asset and Liability Committee (ALCO) thought that the firm's exposure to directional moves in the Nikkei can be neglect. Thus, this led their
*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.
management to neglect market concerns about Barings' large positions. When the bank was took out a large significant of cash, London still did not take any steps or moves to inquiry the demand for funds in Singapore. This is mostly because the senior management thought that a large proportion of these funds represented advances to clients. BFS had only left one third-party client with its own which is Banque Nationale de Paris in Tokyo. The rest were clients from the London and Tokyo offices. There was either Leeson had gone out recently and won some very profitable accounts or Tokyo and London had a new super salesman who brought new business with him. But there is 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, it must have adequate capital. Every institution must have sufficient capital to resist the impact of adverse market moves on its outstanding positions. Barings management was willing and continue to provide financial aid for margin requirements until the contracts is due date because they thought that Leeson's positions were market neutral. Therefore, since the funds were larger than Barings' capital base, the collateral calls from SIMEX and OSE proved that it was too much to bear. As a result, the Barings Bank was forced to call in the receivers. Barings was seriously wounded by the funding risk. The collapse of Barings emphasizes that there is a need and important for institutions to pay more attention to the interim funding needs of hedged and semi-hedged positions. Since the senior managers of Barings thought that they were paying margins on hedged positions, they thus continued to fund on Leeson's activities. However, they were actually losing money on outright bets on the Tokyo stock market. These incidents stated that there is a need for Baring's senior managers to know more about hedged positions. As a result, even though Barings was able to borrow enough money or funds to cover its margin costs until the contracts were due, 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, Barings was still unable to cover its margin obligations. This urged the termination of Barings. When the unauthorized Nikkei of about 30,000 contracts was exposed, its fate was over.
*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 pHYPERLINK "http://www.businessdictionary.com/definition/policies-and-procedures.html"olicies and procedures established to provide rationalHYPERLINK "http://www.businessdictionary.com/definition/reasonable-assurance.html" guarantee 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. Like many trading houses, the front and back office has a separation of operational duties. There is also a unit independent which provides 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 applied or controlled him. The system operated by Barings was a *'matrix' management system. This is a system where managers who are based on overseas report to local administrators and 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. Both the leaders of the support functions in Singapore and Jones had reporting lines to the Group-wide support functions in London. However, Bax and Jones told that they did not realize any operationally responsible for Leeson. Bax felt Leeson can directly reported to Baker, his ultimate boss or Walz on trading matters. Otherwise, he could also report to Settlements or Treasury in London for back-office matters. Whereas Jones felt that his responsibility in BFS was only limited to administrative matter and the securities matter of Barings' activities in South Asia. The reporting lines of Leeson for product profitability are not clear as all of his supervisors were argued on who was the real one that responsible for him. Mary Walz, who was the Global head of equity financial products, insisted that she thought the head of equity derivatives proprietary trading in Tokyo which was Fernando Gueler, was in charge of Leeson's every day activities. However, Gueler emphasized that he was told by Baker that Leeson would report to London instead of Tokyo. Because of this, he thus assumed that Walz would be in charge of Leeson. Yet, Walz herself still argued for this and did not admit it. 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 the margin deficiency of approximately US$120 million in error account '88888'. Besides, this error account also showed its initial margin requirement was in excess of approximately US$340 million. Hence, this caused BFS have to write a report and explained about the margin difference on error account '88888'. They also need to give the explanation on its inability to report for the problem. However, no warning was go on in Singapore during that time. Nobody had an inquiry about who was this customer. No one investigated about why this customer was unable to meet margin payments, why he had a huge position and or the credit risk that Barings will faced. The operational heads in London did not receive a copy of the letter since it was not sent out. In addition, Simon Jones also did not press Leeson for an explanation. He handled the matter by allowing Leeson to draft Barings' response to SIMEX. Next, the second incident was also badly dealt and caused the attention of London. Perhaps all the personnel themselves in Barings were also confuse about what was really happened in their bank. On 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. Nobody is able to identify how this large amount of money was come from. According to one of the version of this event is that BFS had traded an over-the-counter deal between Spear, Leeds & Kellogg and BNP, Tokyo. This transaction was done through Leeson and involved 200 50,000 call options, resulting in a premium of 7.778 billion, which costs US$83 million. Next, according to the second version was that there was an 'operational error' had occurred. Both of these versions were very serious. It had brought serious control implications for Barings. Leeson will get to engage in an unauthorised activity if he had sold or broke an OTC option. And if the SLK receivable was an operational error, then Barings had to strengthen 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.
