"I think it shows the financial markets world is a good deal less efficient than we believe.

If we look at our bank statements, we can see computer errors, for example. And at the same time, there's negligence. A lot of people turned a Nelsonic blind eye to what he (Leeson) was doing because he seemed to be bringing in the profits." 1
- David Frost, Executive Producer, Rogue Trader.

"It could happen again because the incentives are the same, if not greater. The rewards are very great and that's a temptation for people." 2
- Neil Wilson, Editor of Futures and Options Week.

Introduction
On February 26, 1995, Barings Bank (Barings) - the United Kingdom's (UK) oldest and one of its most reputed banks - declared it was bankrupt. The bank with a total net worth of $900 mn had suffered losses in excess of $1 bn. These losses were result of the gross mismanagement of the bank's derivatives trading operations by Nicholas William Leeson (Leeson), the General Manager of Barings Future in Singapore (BFS). BFS had been established to look after the bank's Singapore International Monetary Exchange (SIMEX) trading operations. Leeson's job was to make arbitrage profits by taking the advantage of price differences of similar contracts on the SIMEX (Singapore) and Osaka stock exchanges.

In spite of not having the authority, he traded in options and maintained un-hedged positions. He acted beyond the scope of his job, and was able to conceal his unauthorized derivatives trading activities. Due to the senior management's carelessness and lack of knowledge of derivatives trading, the bank landed up in a major financial mess. When Barings finally went into receivership on February 27, 1995, it had an outstanding notional futures position on Japanese equities and bonds of US$ 27 bn (US$ 7 bn on Nikkei 225 equity contracts and US$ 20 bn on Japanese government bond (JGB) and Euroyen contracts).
4 3

Analysts said that the situation demanded that banks the world over must tighten their internal control procedures.

Background Note
Barings was founded in 1762, by Francis Baring who set up a merchant banking business in Mincing Lane in London, UK. The business grew rapidly during the period 1798 to 1814. It became one of the most influential financial houses during the 1830s and 1840s. The British government paid Barings commissions to raise money to finance wars against the US and France during the mid 1800s. During 1860-1890, Barings raised $500 mn for the US and Canadian governments and was regarded as London's biggest 'American House.' Barings was also involved in providing loans to Argentina during this period. In 1890, Barings was on the verge of bankruptcy when Argentina defaulted on bond payments. However, the Bank of England and several other major banks in London came forward to bail out the bank.

Barings advised the royal family on the management of their assets, and also gave advice to small British firms on investing in stocks and bonds. For the next several decades, the bank grew well and earned significant profits. In the 1980s, the bank started operating in the US again. In 1984, Barings acquired the stock broking arm of Henderson Crosthwaite, which later became BSL. Prior to its merger with the banking business (Baring Brothers & Company) in 1993, BSL was run as a separate company (Refer Exhibit I & II for Barings' Organization Chart Pre- and Post-Merger). Incorporated in September 1986, BFS held a non-clearing membership of SIMEX. In February 1992, BFS applied for clearing membership of SIMEX...
6 7 5

Events Leading to the Fall

Soon after joining BSL, Leeson applied and got a transfer to Jakarta, Indonesia. Due to his excellent performance, Barings management promoted Leeson to General Manager of BFS in Singapore in April 1992. In BFS, Leeson's job was to leverage on the arbitrage opportunities on similar equity derivatives between SIMEX and the Osaka stock exchange (OSE). To take the advantage of the arbitrage opportunity, Leeson had to adopt the following strategy - if Leeson was long on the OSE, he had to be short twice the number of contracts on SIMEX . The arbitrage trading strategy required Leeson to buy at a lower price on one exchange and sell simultaneously at a higher price on the other, reversing the trade when the price difference had narrowed or become zero. The market risk in arbitrage was minimal because positions were always matched. Leeson was not given any authority to trade in options or maintain any overnight un-hedged positions...

Why Did it Happen?

Industry analysts felt that the fall of Barings served as a classic example of poor risk management practices. The bank had completely failed to institute a proper managerial, financial and operational control system. Due to the lack of effective control and supervision, Leeson got an opportunity to conduct his unauthorized trading activities and was able to reduce the likelihood of their detection. Analysts felt that this disaster happened for the following reasons. SEPERATION OF FRONT AND BACK OFFICE DUTIES The back office is responsible for recording and settling trades transacted by the front office, by accepting/releasing securities and payments for trades, and reconciling them with details sent by the bank's counterparties and assessing the accuracy of prices...

The End Result

The fall of Barings not only shocked the financial markets world over, it also exposed their vulnerability. On February 26, 1995, Barings was declared insolvent under the UK Insolvency Act, 1986. Administrators were appointed to take control of the assets of the bank and its subsidiaries. A week later, all the assets and liabilities of Barings Bank and its subsidiaries (except BFS) were acquired by the Internationale Nederlanden Groep NV (ING). ING was looking to expand its investment banking business especially in Asia, where Barings had an extensive business network involving merchant banking activities such as investment banking, corporate banking, venture capital and capital markets operations, together with securities trading and asset management. ING paid one pound for Barings and took on the responsibility of paying the entire $1 bn debts that Barings had accumulated...

The collapse of Britain's Barings Bank in February 1995 is perhaps the quintessential tale of financial risk management gone wrong. The failure was unexpected. Over a course of days, the bank went from apparent strength to bankruptcy. Barings was Britain's oldest merchant bank. It had financed the Napoleonic wars, the Louisiana purchase, and the Erie Canal. Barings was the Queen's bank. What really grabbed the world's attention was the fact that the failure was caused by the actions of a single trader based at a small office in Singapore. The trader was Nick Leeson. He had grown up in the Watford suburb of London. After attending university, he worked briefly for Morgan Stanley before joining Barings. At both firms, he worked in operations, but shortly after joining Barings, he applied for and received a transfer to the Far East. His first task when he arrived was working through a back-office mess in Jakarta. The bank was sitting on GBP 100MM in stock certificates and bearer bonds that were not in deliverable form. Many of the stocks had been purchased on behalf of clients. Because the stock market had subsequently declined, the clients were trying to avoid taking deliverythey complained that certificates were in the wrong denomination, not properly document or in physically unacceptable condition. Over a period of 10 months, Leeson worked his way through the certificates, addressing the problems and making delivery. Barings had maintained an office in Singapore since 1987. Called Baring Securities (Singapore) Limited (BSS), it had originally focused on equities, but its volume of futures trading on the SIMEX (today's Singapore Exchange) was growing. Without a seat on the exchange, BSS was having to pay commissions for all its transactions. The next step was to purchase a seat and hire traders. Leeson's accomplishments in Jakarta attracted the attention of Barings management. When he applied for a position within BSS, they not only accepted him, but they made him general manager with authority to hire traders and back office staff. Leeson arrived at BSS in 1992 and started hiring local staff. As general manager, Leeson's job was not trading, but he soon took the necessary exam so that he could trade on SIMEX along with his small team of traders. He was now general manager,

head trader and, due to his experience in operations, de facto head of the back office. Such an arrangement should have rung alarm bells, but no one within Barings' senior management seemed to notice the blatant conflicts. Leeson and his traders had authority to perform two types of trading:
1. transacting futures and options orders for clients or for other firms within the Barings organization, and 2. riskless arbitraging of price differences between Nikkei futures traded on the SIMEX and Japan's Osaka exchange.

Perhaps it was the inherent lack of risk in such trading that prompted people to not be concerned about Leeson wearing multiple hats. Leeson took unauthorized speculative positions primarily in futures linked to the Nikkei 225 and Japanese government bonds (JGB) as well as options on the Nikkei. He hid his trading in an unused BSS error account, number 88888. Exactly why Leeson was speculating is unclear. He claims that he originally used the 88888 account to hide some embarrassing losses resulting from mistakes made by his traders. However, Leeson started actively trading in the 88888 account almost as soon as he arrived in Singapore. The sheer volume of his trading suggests a simple desire to speculate. He lost money from the beginning. Increasing his bets only made him lose more money. By the end of 1992, the 88888 account was under water by about GBP 2MM. A year later, this had mushroomed to GBP 23MM. By the end of 1994, Leeson's 88888 account had lost a total of GBP 208MM. Barings management remained blithely unaware. On February 23, 1995, Nick Leeson hopped on a plane to Kuala Lumpur leaving behind a GBP 827MM hole in the Barings balance sheet. As a trader, Leeson had extremely bad luck. By mid February 1995, he had accumulated an enormous positionhalf the open interest in the Nikkei future and 85% of the open interest in the JGB future. The market was aware of this and probably traded against him. Prior to 1995, however, he just made consistently bad bets. The fact that he was so unlucky shouldn't be too much of a surprise. If he hadn't been so misfortunate, we probably wouldn't have ever heard of him. Traders sometimes speculate without authorization. Presumably, a few are able to cover their tracks. Others are caught. When they are caught, they are fired, and their employer eats the loss. Usually, neither the trader nor his employer has any interest in publicizing the incident. Leeson made headlines precisely because he was so unlucky. By the time he was discovered, he had bankrupted his employer. Publicity was unavoidable.

What is amazing about Leeson's activities is the fact that he was able to accumulate such staggering losses without Barings' management noticing. As Leeson lost money, he had to pay those losses to SIMEX in the form of margin. Leeson needed cash. By falsifying accounts and making various misrepresentations, he was able to secure funding from various companies within the Barings organization and from client accounts. His misrepresentations were flimsy at best. For example, he claimed that he needed funds to make margin payments on behalf of BSS clients, and he gave a technical argument related to how the SIMEX collected margin as justification. This claim was false. It was actually against SIMEX rules for a broker to post its own money as margin for a client. Even if the claim were true, the funds would have been needed only temporarilyuntil the client could make payment. Instead, Leeson continued to ask for ever more funding. Most of this came from three companies within the Barings organization: Baring Securities Limited (BSL)securities arm of parent Barings Plc.; Baring Securities (London) Limited (BSLL)BSL's London office; Baring Securities (Japan) Limited (BSJ)BSL's Japan office. Exhibit 1 tracks the funding of BSS by these three companies in the months leading up to Barings' collapse.
Sources of Funding for BSS During Early 1995
Exhibit 1

Funding for Baring Securities (Singapore) Limited (BSS) came primarily from three companies within the Barings organization. This exhibit tracks their funding of BSS in the months leading up to the failure of Barings. Essentially all the funding was used by Leeson to make margin payments to SIMEX. Source: Bank of England.

Despite his having to fund millions of GBP in losses, there were various factors that allowed Leeson to avoid discovery. At the time, there was a merger going on between two parts of the Barings organization. Barings had acquired stock brokerage Henderson Crosthwaite in 1984, which became BSL. Originally, BSL was run as an entirely separate company from the banking business, which was called Baring Brothers and Company (BB&Co.). This is indicated in Exhibit 2.
Barings Organization Prior to Merging the Banking and Securities Businesses
Exhibit 2

An abbreviated organizational structure for Barings prior to the 1993 merging of BB&Co. and BSL. Entities not relevant to this article have been omitted. For example, BSL also had offices in New York and Hong Kong.

In November 1993, BSL was merged into BB&Co. in anticipation of a subsequent initiative to form a Barings Investment Bank (BIB). The merger was not easy because the two firms had markedly different cultures. It was a distraction right in the middle of Leeson's tenure at BSL. The new organizational structure following the merger is indicated in Exhibit 3.
Barings Organization Following the 1993 Merger of the Banking and Securities Businesses
Exhibit 3

An abbreviated organization structure for Barings following the 1993 merging of BB&Co. and BSL. In 1994, BB&Co. and BSL became part of the new BIB.

Barings was just starting to form a risk management function. Risk controllers were appointed in London, Tokyo and Hong Kong during 1994, but not in Singapore. In BSS, Leeson effectively controlled the front and back offices. There was no middle office. Also, there was no single person within Brings responsible for supervising Leeson.

As part of the 1993 reorganization, Barings had adopted a "matrix" approach to management of its offices. There was one reporting structure based upon products that cut across all offices. Another was based upon operations, ensuring local management of such items as systems, controls, settlement and accounting. Employees complained that lines of reporting were not always clear. Leeson was involved with two "products"futures arbitrage and trade execution for clients or other companies within the Barings organization. During 1994, his "product" line of reporting could arguably have been to either Ron Baker, who managed derivatives, or Mike Killian, head of Global Futures and Options Sales. Locally, Leeson could have reported to James Bax, who was head of the Singapore office, or to Simon Jones, who was Regional Operations Manager for South East Asia. Another issue was that Leeson was an accomplished liar. He falsified records, fabricated letters and made up elaborate stories to deflect questions from management, auditors and even representatives of SIMEX. Leeson actively played on people's insecurities. He notes in his (1996) book Rogue Trader that:
People at the London end of Barings were all so know-all that nobody dared ask a stupid question in case they looked silly in front of everyone else.

Some people did raise concerns about Leeson's activities. In a January 1995 internal e-mail, Brenda Granger, Head of Futures and Options Settlements in London stated
Awaiting breakdown from my buddy Nick (once they creatively allocate the numbers).

Such concerns went largely unheeded. Leeson was a celebrity within Barings. While he was secretly accumulating losses in account 88888, he was publicly recording profits in three arbitrage trading accounts, numbers 92000, 98007 and 98008. This was accomplished through cross-trades with account 88888. By performing futures transactions at off-market prices, Leeson was able to achieve profits in the arbitrage accounts while placing offsetting losses in the 88888 account. During 1994, Leeson booked GBP 28.5MM in false profits. This was a staggering profit to earn from futures arbitrage, but it ensured that Barings employees earned bonuses that year. Needless to say, there was little incentive for employees to question the unusually high arbitrage profits. If anything, Leeson was viewed as a star trader who was not to be interfered with.

In a famous 1993 quote, Peter Baring, Chairman of Barings, commented to Brian Quinn, Director of the Bank of England that
The recovery in profitability has been amazing following the reorganization, leaving Barings to conclude that it was not actually terribly difficult to make money in the securities markets.

Six days after fleeing Singapore, Leeson was arrested in Frankfurt trying to make his way back to London. He was returned to Singapore to stand trial. Convicted of fraud, he was sentenced to six and a half years years in Singapore's Changi prison. While there, he contracted cancer, which he survived, and was divorced by his wife. For good behavior, he was released from prison early, in July 1999.

Barings Bank Report Document Transcript

1. What is the Role of Investment Bank in Derivatives Trading? Investment bank is a financial institution that acts as an agent for individual investor or institutional investor in providing services like information facilitate transaction and operates investment activities for clients. Unlike commercial bank, investment does not provide deposit service. Investment bank basically involve in trading securities for cash or security, facilitating transaction, market making, and promoting securities (underlying or research) for the sell side. It also deal with mutual fund, hedge fund, pension fund and investing public who consumed the securities and services offered by the sell-side in order to maximize their return on investment constitutes the buyer side. In the derivative trading, investment bank is holding a significant role in helping individual or institution investors. They usually act as agent for their client to involve in derivative trading in the exchanges. They buy and sell the derivative contracts on behalf of clients to fulfill the clients objective either earning arbitrage profit, speculating or hedging. Besides that, investment banks are also helping their clients in creating derivative contracts to raise fund or hedging either traded at OTC market or ETD market. In order to do so, investment banks have developed their research team to analyze the derivative market. In order word, investment banks also provide advisory services for their derivative trader. The

information provided is necessary for traders to analyze the derivative market and making right decision. This is related with the front offices responsibilities.

2. Besides that, investment banks also performing risk management services for their clients. They are responsible to make sure the credit risk and operational risk are reasonable and acceptable for every trader either buyer or seller. Sometime, they also act as a clearing house to eliminate the counter-party risk in the OTC market on behalf of their client. Moreover, investment banks will help their clients in compliance with the exchanges rule and regulation. This is their responsibilities to make sure every transaction is following the regulation to protect themselves and their clients. These types of services are usually performed by middle office unit. Furthermore, investment banks also accountable for every single transaction. They usually perform trade confirmation to make sure the accuracy of each transaction and reduce the default risk either caused by their workers or trader himself. Investment also provide software and technology platform to assist the front office in trading and providing information to the clients. For example, investment bank will link their website with the exchanges database to show the performance of certain derivative contracts for their clients. This increase the efficiency and effectiveness of the whole investment banks operation. Investment bank is an important party in the derivative trading.

3. What is Derivatives? Definition of Derivatives Derivative is one of the financial instruments which are actively traded in the derivative market around the world. This financial instrument is an agreement between two different parties which the value of the instrument is determined by contingent future outcome of particular underlying factors. Those factors can be changed due to commodities price, share price, index, interest rate, value of currency, foreign exchange rate, and credits and so on. There are several types of derivatives, commonly such as futures, forwards, options, and swaps. However, since the derivative can be positioned on any kind of securities, thus, the scope of the type of derivative is boundless. When study a derivative instrument, basically we have to look for the relationship between the underlying and the derivative, type of underlying, which market being involved, and the purpose of investing in such market. The following table show that the increasing of size of derivative market since 1990 to 1996.

4. Types of Derivatives Market The derivative market is the financial trading market for derivatives. In broad terms, there are two different derivative markets which are Over-The-Counter derivative market (OTC) and Exchange-Traded derivative market (ETD). Over-The-Counter derivative market (OTC) is designed to serve contracts traded directly between the seller and buyer which privately negotiated without going through any intermediary or exchange body. OTC is the largest market for derivative trading compare to the ETD market. The traded derivatives are normally tailor-made derivatives which fulfill the need of both side traders because it is privately negotiated by both parties and without going through any intermediary. This is the benefit of trading in the OTC market. However, due to this freedom in trading, OTC derivative market is also the largely unregulated market with respect to the disclosure of information between both parties. Reporting of OTC amount is difficult to be noticeable since the trades are taking place privately,

without activity being observable on any exchange. Therefore, OTC derivatives are subject to higher counter-party risk compare to the ETD derivatives. Examples of OTC derivatives are swaps, forward rate agreements, credit derivatives and so on.

5. Exchange-Traded derivative market (ETD) is created to serve derivatives that are standardized contracts through specialized derivative exchanges. A derivative exchange acts as an intermediary to all related derivative trading. They will incur an initial margin for the traded derivatives from both parties as a guarantee. Since the trading is under the control of the derivative exchanges, the counter-party risk is much lower compare to the OTC derivative market. The derivative exchange provides investor access to information of the trading and guarantees the performance of the contract. The worlds largest derivative exchanges are the Chicago Board of Trade, Chicago Mercantile Exchange, Korea Exchange and so on. Examples of ETD derivatives are options and futures contracts.

6. Types of Common Derivative Contracts As mention before in the definition of derivative, there are three common classers of derivative which are future/forward, option, and swaps. In derivative, futures contract is a standardized contract between both buyer and seller on a specified asset with standardized quantity and quality at a particular future date with a price agreed today (future price). Futures contracts are normally traded through future exchange. A futures contract is different from forward contract because it is a standardized contract written by clearing house while forward contract is a non- standardized written by the parties themselves. The responsibilities of clearing house are to minimize the counter-party risk and monitor the exchange of future contract. They act as the buyer for the each seller and the seller for the each buyer. Thus, function of clearing house will eliminate the need of performing due diligence by both parties. Besides that, in order to reduce the credit risk, traders are also been required to post a margin or a performance bond which normally around 5% to 15% of the contracts value. The futures contract can be settle with two ways. First is physical delivery. The seller will deliver the underlying asset with the specified quantity and quality to the exchange and then, to the buyer of the contract. It usually involves

7. commodities and bond delivery. Second is cash settlement. A cash payment is made based on the underlying reference rate such as index and interest rate. Both parties settle the contract by receiving/paying the gain/loss related to the futures contract in cash when it is expires. An option is different from futures. Option giving the owner the right but not the obligation to buy or sell a particular asset. An option to buy something is called as call option while option to sell something is called as put option. An option usually sold by the creator to another buyer. It can be standardized form of contract traded in exchanges like commodities option or contract customized to the desires of the buyer traded in OTC market. The option contract usually contain certain specification such as quantity and class of the underlying asset, strike price, expiration date, settlement terms and so on. Besides that, option contract can also be categorized into two different types due to the exercising period of the option. First is European option which the owner has right to exercise the option only at maturity date. Second is American option which owner has right to exercise the option at any time up to the maturity date. If the

owner exercises the option, counter-party has the obligation to carry out the transaction. The following will be the basic trades of option. Premium is the option price the pay by the trader to obtain the option. Long call option will be traded when the trader believes that price of the underlying asset will increase. Trader will only exercise the option to buy the underlying asset if the price of the

8. underlying asset higher than the strike price. Profit will be earned if exercise price greater than premium plus strike price. Long put will be traded when trader believes that the underlying assets price will decrease. Trader will only buy the underlying asset if the price of underlying asset is lower than the strike price. Profit will be earned if exercise price lower than the strike price plus premium. Short call option will be traded when the trader believes that the price of underlying price will decrease. The trader selling the call have obligation to sell the underlying asset to the option buyer. If the price of underlying asset is lowers than the strike price, the trader will earn a profit in the amount of premium. Short put option will be traded when trader believe that the price of underlying asset will increase. The trader selling the option will has obligation to buy the underlying asset from the owner of option. If price of

9. the underlying asset is higher than strike price, the trader will earn a profit in the amount of premium. Swaps is an financial tool which counter-parties exchange certain benefits of one partys financial instrument for those other partys financial instrument. The benefit will be defined by both parties so that it will fulfill their needs. Swaps contract is due with the exchange of cash flow on or before a specified future date based on the underlying value of assets. For instance, two counterparties agree to exchange one stream of cash flow against another stream. This contract can be used to hedge certain risks or to speculate on changes in the expected direction of underlying prices. Basically, swaps contracts are traded at OTC market, thus, it can be tailor-made for the counterparties. Purposes of Investing In Derivative Market Since the derivative market is growth rapidly, it will be necessary for us to understand the reasons of invest in the derivative market. Basically, there are four reasons of investing in the derivative market as follow: To speculate and make profit due to the changes of the value of the underlying assets. To hedge or mitigate risk incurred in the underlying asset by entering into a derivative contract which the value of the derivative contract is opposite direction compare to the underlying position as whole or part of it. To exposure to underlying asset which it is not possible to trade in the underlying asset market.

10. To create optionability where the value of the derivative is linked to a specific condition or event. Hedging In finance, hedging is a strategic to mitigate or eliminate risk exposure to the price fluctuation of the assets or the availability of the assets. In this respect, derivative market can be considers as a important financial instrument in hedging. Normally, hedging strategic will trade with the ETD market because of the involvement of third party, named clearing house which helping in mitigate the counter-party risk and default risk. To reduce the risk of price fluctuation, derivatives such as future or forward contract is work with it. For example, an individual investor or institution who involve in stock trading can exercise hedging strategic by buy stock at the underlying market and sell the

futures contract which the value of the derivative is linked to the performance of same stock but in the opposite direction. The risk of price fluctuation is eliminated in such situation because when stocks price fall in the underlying market, the value of the futures contract will increase in the same manner and vice versa. This hedging strategic is useful especially when the volatility of underlying market is high. Besides that, risk of availability of asset can also be mitigated by using derivatives. For instance, a logistic company can create a futures contract or option contract with the fuel producer like Shell to secure the availability of fuel in the future. The derivatives will reduce future risk for both parties. Logistic company will sure to obtaining the fuel and fuel producer will reduce price fluctuation risk.

11. Speculative and Arbitrage Besides hedge against risk, derivatives contract can also be used to acquire risk in order to earn profit. Some institution or individual enter into the derivative contract to speculate on the value of underlying assets. Those speculators will forecast the future price movement of certain underlying asset and create derivative contract to gain profit from it. Speculator will want to buy as asset in the future at a low price according to a derivative contract when future market price is high, or to sell an asset in the future at a high price according to a derivative contract when the future market price is low. Besides that, some individual or institution is also looking for arbitrage opportunities in the derivative market. Arbitrage profit is derived from the changes of price of underlying asset between the time of sell and buy. They will gain the arbitrage profit if the purchase price is lower than the future exercise price of the particular underlying assets. Not matter speculative or arbitrage, it normally involves high risk. Huge loss maybe incur to the individual or institution. Since the speculative and arbitrage strategic is wholly depend on their forecasting ability. Such uncertainty of the underlying asset will increase the probability of loss. The Barings Bank case is the best example in explaining this condition. The fall of Baring Bank was due to the wrong estimation of Nikkel 225s performance by Nick leesons and the volatility of the changes of Nikkel 225 in the market. So, massive loss may suffered by speculator and arbitrager.

12. Introduction of Barings Bank and Nick Leeson Barings Bank was founded in London in 1763 which rose to become the Britains oldest Merchant Bank as well as becoming the leading Merchant Bank. As such, it provided traditional banking services to the public while performing investment activities in stocks, bonds, commodities and real estate. The bank focused in investment sector activities which could lead to success in trading on the future. By 1989, Barings had established trading operations at most of the worlds exchanges operating began in British Commonwealth countries and former British colonies. By being creative and flexible in crafting the financial solutions for organizations, Barings Bank enjoying grew up steadily over time across the globe. In February 1995, the bank was discovered in involving a huge fraud scheme, perpetrated by one of its traders in Singapore-Nick Leeson. He had wiped out the banks capital and destroyed the 220 year old institution. Previously, Nick Leeson had graduated from college and spent two years at Morgan Stanley as a settlement clerk and in duties on clearing the huge futures and options deals. In 1989, this young commodities trader joined Baring Securities Ltd (BSL) and working primarily in the settlements department. In

the mean time, he had applied to become a dealer with the Securities and Futures Authority (SFA) in London early 1992. After the first quarter of 1992, Leeson was posted to Baring Futures Singapore Ltd (BFS) to perform the settlement operations as well as the floor manager at the Singapore International Monetary Exchange (SIMEX). This is the beginning opportunity for Nick Leeson to bring down the Barings Bank due to the inconsistency of the risk management fundamental. Leeson was selected to open, run and manage the new operation in Singapore, managing all aspects of trading on SIMEX and he

3-month Euroyen contract dealt in SIMEX and TIFFE (Tokyo Financial Futures Exchange) in the Japan. 10 year JGB (Japanese government bonds) contract dealt in SIMEX and OSE. Nikkei 225 contract traded on SIMEX in Singapore and OSE (Osaka Stock Exchange) in Japan 13. had been with the Barings Bank approximately three years and possessed a total of five years experience in banking. What was the strategy being implemented by Nick Leeson which caused Barings Bank to face huge losses? Around 1990s, derivative market is rapid growth financial instrument around the American and European markets even the Asia-Pacific region. The Barings Bank board was decided to actively participate in the Asia-Pacifics derivative market in order to become one of the first active bankers in the derivative market. That is the reason for Barings Bank employed and sent Nick Leeson, a young trader as general manager of the Barings Bank Futures subsidiary in Singapore to manage the derivative operation. Nick Leeson was given a lot of freedom by Barings Bank in the derivative trading since he was the one who deem to know very well of the derivative market operation. He was appointed to in charge of both client and proprietary account on behalf of Barings Bank trading in Asia-Pacific region. He was traded in several main financial futures and option exchanges as following:

14. In the early state, Barings Banks management was planned to operate an inter- exchange arbitrate strategy. This strategy required Nick Leeson to buy and sell Nikkei 225 futures contracts simultaneously on both SIMEX and OSE market in order to gain the arbitrate profit from the different in price of the Nikkei 225 futures contracts. ( Buying at lower price and selling at higher price). This strategy would consider as a risk-free investment and provide good opportunity for profit in the high volatile market. However, due to the contracts price is slightly different, the profit earn is small. Because of this, Nick Leeson was decided to change the strategy. The strategy implemented by Nick Leeson named as straddle with the objective of making a profit by short put and call options on the same underlying assets Nikkei 225 Index.

15. This graph explains how the straddle strategy works. A short call option will gain profit only when the price of underlying asset is lower than the strike price. The profit earned is the premium from selling the option. For a short of put option, profit will be gained when the price of the underlying asset is higher than the strike price so that the owner will not exercise the option. The profit amount is same with the premium from selling the option. With the combination of short call and put option, Nick Leeson will be able to develop the above graph. From the graph, we can see that the profit portion is small and only happen if the price of underlying asset is

close to the strike price (maximum profit when exercise price same with strike price). When the price of underlying asset is higher or lower than the break-even point, Nick Leeson will suffer huge loss as shown by the graph. The loss volume will increase with the raising of volatility of the price of underlying asset. In short, we understand that straddle strategy will only provide positive earning when the market is stable.

16. Is the Nikkei 225 Index is a stable financial instrument? Nikkei 225 is a stock market index for the Tokyo Stock Exchange (TSE). It represents a price-weighted average of the Japanese stock market. In year 1986, Nikkei 225 futures contracts had been created and introduced at SIMEX, OSE and Chicago Mercantile Exchange (CME). It is now an internationally recognized futures index. The graph is showing the performance of Nikkei 225 Index during1970 until 2010. It clearly shows that the Nikkei 225 Index was fluctuated throughout the whole year. This caused the loss suffered by Nick Leeson keep on increasing. The situation went worse when the Kobe earthquake happened in Japan during year 1995. The Nikkei 225 Index dropped 1000 points approximately which deteriorate the Barings Banks loss. The following graph is showing that the loss of Barings futures position and the drop of Nikkei 225 Index during January and February of year 1995.

17. On 27 January 1995, the account 88888 showed a long position of 27,158 March 1995 contracts. In order to cover the loss, Nick Leeson decided to double up the long position to 55,206 March 1995 and 5,640 June 1995 contracts. This decision was based on the forecasting make by Nick Leeson who believes that the Japanese market to recover very soon and the Nikkei 225 Index increase and become more stable. In fact, Nick Lesson estimation was wrong. The Japanese market was not recovered in the short time and cause the loss suffered by Nick Leeson keep on increasing. Because of the terrible forecasting and straddle strategy, Nick Leeson sent Barings Bank to the collapse due to high loss suffered. It is also Nick Leesons crime which he changed the investment strategy from interexchange arbitrage to straddle strategy and cover the loss using other accounts.

18. What are the Reasons that led to the Fall of Barings Bank? Lack of internal checks and balances In July 1994 until August 1994, the internal auditor of Barings Bank, James Baker has spent two weeks in Singapore to investigate the suspicious profits being made by Nick Leeson. James Baker identified the weaknesses in the internal controls in Barings Bank and recommended that the General Manager should not responsible for the back office in order to avoid the conflict of interest deficiency by holding two position at the same time in the organization. In response to the suggestion given by Baker, Barings Bank had taken their action by simply appointed the part time separate financial manager in Hong Kong to watch over the back office activities. This action taken by management was insufficient in monitoring Leesons activities, indeed. Leesons activities could not be effectively supervised due to the incompetency of management. No Segregation of duties Barings Future Singapore (BFS) was facing difficulties when Leeson was permitted to remain the responsible for both front office and back office. Although the management of Barings did not noticed about the existence of the unauthorized activities being made by Nick Leeson, but, the internal auditor did suggested the

recommendations to improve the separation of roles in the Barings Bank. In fact, these recommendations were never been implemented. The internal report was introduced widely among management in London and was generally acknowledged as crucial. Copies of internal audit report were distributed to

19. i. Norris, Chief Executive Office of Barings Investment Bank (BIB) ii. Broadhurst, Group Finance Director of Barings Investment Bank (BIB) iii. Hopkins, Director of Group Treasury and Risk of Barings Investment Bank (BIB) iv. Barnett, Chief Operating Officer of Barings Investment Bank (BIB) v. Ron Baker, Head of Financial Product Group (FPG) As we can see above, the top level management had been acknowledged about the matter happened in Barings Bank. Yet, by February 1995, nothing had been taken in order to implement the recommendations of the reports as to segregate the duties of Nick Leeson. Most of those who had received the internal audit report claimed that, it is the responsibility of others (mainly in Singapore) to implement the recommendations. The discrepancies happened between the management allowed Nick Leeson to freely perform his unauthorized trading during his period in BFS. At Singapore itself, Simon Jones, the Director of Barings Future Singapore (BFS) (who had also responsibility for Barings operations in Singapore) seems like have not taken any significant steps to give effect to the recommended segregate of duties toward the Nick Leeson position. He should immediately restrained Leeson to perform certain functions in settlement and recording processes after being acknowledged by the internal audit report.

20. Unauthorized trading activities The unauthorized trading was concealed by differences of devices including the error account 88888, the submission of falsified reports to London, the misrepresentation of the profitability of Barings Future Singapores (BFS) trading, a number of false trading transaction in cross trade and false accounting entries. All this activities was done by a single personNick Leeson who was claimed as rogue trader. The creation of 88888 account Even the segregation of duties was suggested by the internal auditor, but Barings Bank diluted the concentration toward the Nick Leesons power. Nick Leeson was being able to possess his authority to make decision in managing cheque, signing authority, authority to sign off on trading reconciliations and responsible for inspection in bank reconciliations. According to Nick Leeson, he was asked by the London office of Barings to create another error account in order to handle only trivial items arising in Singapore. Since that, the error account namely 88888 was created by Leeson and he used this opportunity to manipulate any premiums or losses that he made in the derivatives transactions. Because of the lack of internal checks and balances and the birth of the error account (88888), Nick Leeson was able to make his gambles activities in the derivatives market and cover for his shortfalls by reporting losses as gains to Barings in London. Leeson had took his tricky action in altering the error account in order to prevent the London office from receiving the standard daily reports on trading, price and status. By using the hidden five eight account, Leeson began to actively trade in futures and options on SIMEX. The money entrusted to the bank by subsidiaries was being

21. used by Leeson within his own 88888account. He made a false statement in trading records in the banks computer systems and used money intended for margin payments on other trading. Leeson's Positions as at End February 1995. Number of contracts1 nominal value in US$ Actual position in terms of open interest of amounts relevant contract2 Reported3 Actual4 Futures long 61039 30112 49% of March 1995 contract and 24% of June Nikkei 225 $7000 $2809 million 1995 contract. million short 28034 15940 85% of March 1995 contract and 88% of June JGB $19650 $8980 million 1995 contract. million short 6845 5% of June 1995 contract, 1% of September 601 Euroyen $350 1995 contract and 1% of December 1995 $26.5 million million contract. Options 37925 calls $3580 million Nikkei 225 Nil 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 Euro yen, SIMEX and TIFFE contracts are of similar size.

22. 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, or the Singapore International Monetary Exchange or the Tokyo Stock Exchange. 4. The actual positions refer to those unauthorized trades held in error account '88888'. 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 The Cross Trade A cross trade is a transition executed on the floor of an exchange by just one Member who is both buyer and seller. He is allowed to cross the transaction (execute the deal) only if he can matching buy and sell orders from two different customers accounts for the same contract and at the same price. However, he can only apply this method after he had declared the bid and offer price in the pit (trading) and no other Members has taken it up. Under SIMEX rules, the Member must declare the prices for three times and the cross trade must be executed at market price. Leeson entered into a significant quantity of cross transactions between account 88888 and account 92000 (Baring Securities Japan Nikkei and JGB Arbitrage, account 98007 (Barings London-JGB Arbitrage) and account 98008 (Barings London-Euroyen Arbitrage).

23. After executing these cross trades, Leeson would instruct the settlements staff to split down the total number of contracts into several different trades and changing the trade price in order to affect the profits to be credited to switching accounts (92000, 98007, and 98008) and the losses to be charged into account 88888. Thus, these transactions and manipulations activities taken by Leeson caused the cross trade on the Exchange appeared on a genuine and within the rules of the Exchange. No. of Price Average Value Value per Profit/(Loss) contracts in per Price per per CONTACT to 92000 account SIMEX CONTACT SIMEX JPY JPY millions 88888 2 JPY millions millions Buy Sell 20 6984 18950 19019 66173 66413 240 January 23 3000 17810 18815 26715 28223 1508 January 23 8082 17810 18147 (71970) (73332) (1362) January 25 10047 18220 18318 91528 92020 492 January 26 16276 18210 18378 148193 149560 1367 January Total 2245 1. This table is related to the Report of the Board of Banking

Supervision Inquiry into the Circumstances of the Collapse of Barings, Ordered by the House of Common, Her Majesty's Stationery Office, 1995.

24. 2. This column represents the size of Nikkei 225 cross-trades traded on the floor of SIMEX for the dates shown, with the other side being in account 92000. Table 10.3 below is an example of how Leeson manipulated his books to show a profit on Barings's switching activity. We notice that lack of internal checks and balance in an organization could lead to disaster just like Barings Bank did. Leeson could simply cover his action within his capabilities and authority through using loophole in the Barings Banks internal controls. Lack of understanding in the derivative markets The Bank of England summarized that Barings Banks senior management team did not understand the risks incur represented by the instruments that Lesson could potentially trade. Leeson engaged in the certain options trading strategies that created downside risk (potential loss if price decline) for the company under some market conditions even he was not authorized to do so. Leeson sold options and using the straddles strategy, the former, in order to cover up his activities each month and he try to manage his losses(not manage the loss). Straddles are a potentially highly profitable trading strategy which involving both put and call options and it is suitable

25. for the person who expects a neutral and low volatility market in the underlying securities. If the Barings Banks auditors and top management had understood the derivative trading business, they will had realized that it is not possible for Leeson to be making the profits as reported without taking the risk into considerations. Furthermore, they might have a lot of questions to ask where and how the money was coming from to cover the losses(no include cover loss). After the several months, Leesons activities was only started to be tracked and revealed after the Kobe earthquake in Japan happened on January 17, 1995. Leeson initially took his action to transact the put and call options within a massive volume in hoping that the Nikkei market will goes up quickly to obtain the profit and cover his losses that he has made. But, in contrast, the Japans market keep on dropping to loss and Leeson could not afford the pressure for being keep on conceal the loss. At the end, the entire activities that Leeson had made were completely pulled down the Barings Bank. At that point of time, every party in the management realized that everything was too late to be recovered Poor supervision of employees and lack of senior management involvement There was an oversight on Leesons activities and no individual was directed to monitor his trading strategies although Leeson had never held a trading license prior to his arrival in Singapore. Even each department was being fragmented, no one or no department had a clear overview of what was going into the bank? Nick Leesson personally claimed a severall statement that: i. Anybody who was supposed to have some control over his activities was going elsewhere.

26. ii. The people who were looking after the traders were based in London. iii. The people in charge of the compliance function were in London. iv. The risk management areas were in Tokyo v. He was both the senior trader and settlements person in Singapore This clearly showed a very serious and obvious implication to the Baring Bank itself. Besides, Nick Leeson was exposed to the fraud activities.

Although the above matter has been pointed out regularly in audits (internal and external), but no action had to be taken to overcome the weaknesses. 1.0 Simon Jones - The Finance Director of Barings Future Singapore (BFS) Going into more details, Leesons back office functions were never effectively monitored. The staffs in the back office in Singapore were relatively junior and they simply obey Leesons instructions. The Finance Director of BFS, Simon Jones, was concerning himself primarily with the affairs of Barings Securities Singapore (BSS) and devoted little attention to Barings Future Singapore (BFS). While, no appropriate degree of supervision and internal controls was being implemented to overcome these weaknesses. Thus, BFS was operated almost entirely by Nick Leeson alone. This lack of supervision was reflected in the failure on the part where Jones was dealing with satisfactorily with the letters of SIMEX to BFS on 11 January 1995 and 27 January 1995. Both of these letters was very crucial to reveal the Leesons activities regarding on poor management. 1.1 The letter on 11 January, 1995

27. SIMEXs senior vice president for audit and compliance, Yu Chuan Soo, complained that, i. A margin shortfall about US$116 million in account 88888 had been incurred and this had showed the SIMEX rule 882 was violated (by previously financing the margin requirements of this account which was appeared in SIMEXs system as a customer account). ii. Initial margin requirement of account 88888 was in excess of US$342 million. Barings Future Singapore (BFS) was being asked to provide a written explanation of the margin difference on account 88888 and also explain about its inability to account for the problem in the absence of Leeson. In fact, no warning or caution went into the BFS and no one investigated who was the real customer. Furthermore, nobody investigated why Leeson was having difficulties in meeting margin payment, and why he had such a huge position for margin requirement in account 88888. Unfortunately, Simon Jones, (who was legitimately responsible to inspect the condition happened) was not sent a copy of the letter above to the Operational Heads in London and he also did not asked Leeson to give detail explanations about the above matters. Indeed, Jones dealt with the matter by just allowing Leeson to draft the response to SIMEX and this affected the London received the wrong (or edited) information. 1.2 The letter on 27 January, 1995 Second, the letter of 27 January 1995 related to the assurance of BFSs ability to fund its margin calls. Although a copy of this letter was sent to Barings in London, but Jones did not investigate why such letter had been sent.

28. This second letter was related to the incident which is come to the attention of London. But, it again, was dealt with unsatisfactorily by the management. At the initial period of February 1995, Coopers & Lybrand brought to the attention of London and Simon Jones the fact that, US$83million apparently due from Spear, Leeds & Kellogg (a US investment group) that had not been received. Again, no one was sure on how this multi-million dollar receivable arose. There have two version explaining the above matter. One is, in BFS (through Leeson), had traded (or broken) an over-the-counter deal between Spear, Leeds & Kellogg and BNP, Tokyo. The transaction involved 200 of 50,000 call options and resulting in a premium of US$83million. The second version is, an operational error had occurred (a payment had been made to a wrong third-party in December 1994) No matter what version it was, these had serious control implications from Barings

Bank. If Leeson had sold (or broken) the deal in an OTC option, then he obviously had engaged in an unauthorized activity. Yet, he should be warned for doing the activities. In fact, there is no any record of Barings Banks management to take any actions or steps to ensure that the matter above did not happen again. If the Spear, Leeds & Kellogg receivable was facing an operational error, Barings Bank had to strengthen its back-office procedures in order to avoid the same mistake occur again 2.0 Fernando Gueler - The Head of Financial Product Group (FPG) in Barings Securities Japan (BSJ) The lack of supervision of BFS was extended elsewhere. Fernando Gueler, the Head of Financial Product Group (FPG) in Barings Securities Japan (BSJ) was based in Tokyo and experienced in the operation of Japanese markets, and he also responsible in analyzing the risks on Leesons intra-day trading activities from 1992 until the last

29. quarter of 1994. The matter is, he did not have a clear understanding of his duties in supervision over BFSs trading activities and he argued that he was responsible for supervising Leesons switching activities. He should knowingly that BFSs trading activities were not properly supervised and he should not have allowed this lack of proper supervision to continue. Ethical point of views Person who was attracted to unethical means for self interest which refer to the advancing their careers and strengthen their financial position was often driven by the intention to defense their own poor self image. The person will act themselves favorably while, try to avoid from being detected. From the case of Barings Bank, Nick Leeson who was above his capability in trading and managing at BFS intentionally created a dummy account in order to absorb his substantial trading losses (according from Leeson, 1996) for two years. Finally, this unethical behavior performed by Leeson collectively lead to the collapse of Barings Bank on 1995. The case of Barings Bank leads to the awareness of ethical behavior in banking organization as well as corporate world in order to prevent and avoid the same situation to be happened again. It is therefore easy to conclude that: The losses were incurred by reason of unauthorised and concealed trading activities; The true position was not noticed earlier by reason of a serious failure of controls and managerial confusion within Barings; and that The true position had not been detected prior to the collapse by the external auditors, supervisors, or regulators of Barings.

30. What are the roles of internal audit, external audit, corporate governance and risk management in mitigating risk arise since the collapse of Barings Bank? In the Baring case, lack of proper supervision from the top management and deficiencies in internal control and risk management of the organization had led to the arisen of operational risk, which led to the collapse of financial giant, Barings. The Basel Committee defines operational risk as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Risk Management

31. Risk management is crucial in a company where it can identify the risk areas of an organization. Once the risks have been identified, management would take further actions to reduce the risks to a tolerable level. Obviously, there was deficiency in Barings Banks risk management. Basically, the risk in Barings was

arising from the incident as follow:- (i) No proper supervision from the management over the activities done by Nick Leeson (ii) Senior executives had no understanding about the business of derivative trading (iii) There was no segregation of duties Those incidents as above had created operational risk to Barings. In order to mitigate the operational risk, the management has to play its role before pointing fingers to others when the problems happen. The management has to implement enterprise risk management where it could identify potential events that may affect the bank and manage risks to be within its risk appetite. The bank should always establish the risk culture and have a proper policy that help to ensure the risk response is carried out, considers risk strategy in the setting of objectives, determine the risk appetite; differentiate the events whether they are an opportunity or threat, assess the risk with qualitative and quantitative risk assessment methodologies and response to risk with proper actions. If these would have implemented by the Barings Banks management, they could have identify the risk and take appropriate action when they were informed by the internal auditors that there was a problem in the control system in Barings Future Singapore. Hence, Barings Bank might still exist now.

32. Without proper supervision from the management Corporate governance defined by Gabrielle O Donovan as an internal system encompassing policies, processes and people, which serves the needs of shareholders and other stakeholders, by directing and controlling management activities with good business savvy, objectivity, accountability and integrity. In Barings case, the board and top management were considered as failed to implement their fiduciary duties for the benefits of shareholders and company. It is because the top management was said to have little oversight over the activities done by Nick Leeson even though he was just got his trading license during that time. Hence, it provided amble of opportunities to Nick Leeson to perform unauthorized trading and hide losses from the sight of management. Due to huge losses made by Nick Leeson, Barings Bank collapsed eventually in 1995. After this incident, the management of each organization should take this as a lesson by having proper supervision and monitoring over their subordinates activities. It is crucial to ensure that activities done by subordinates or employees are mainly for the benefits of the organization. Lack of understanding about derivative trading After the incident happened, the top management claimed that they did not understand the business of derivative and how the transactions were operated. Due to this problem, they can only provide guidance to Nick Leeson based on quantitative elements such as profit figure rather than strategy in nature. Senior executive would rather to encourage Nick Leeson to obtain higher profit rather than investigate how Nick Leeson would be able to get such a high profit from trading in arbitrage between

33. future contracts, which were low risk in nature. Based on the risk management principles, low risk would have low return and vice versa. Arbitrage profit is usually much lower than the speculation profit. The management of Barings seems like ignore about the basic principles and that is why they failed to detect the fraud done by Nick Leeson in the derivative trading. Due to such problem, the top management should be sent to training or attend courses to enhance their knowledge about derivative market and to be able to become the all rounder in the banking industry

deal with derivative trading. This could increase the competencies of the top management to supervised their subordinates and understand what they are doing in the operations. By attending the courses, the top management would have better understanding about the nature of derivative business which in turn could provide proper recommendations and guidance to subordinates. Thus, it helps to mitigate the operational risk. Without segregation of duties Nick Leeson was given two responsibilities, which were appointed as floor manager of Barings Future Singapore to deal in Singapore Money Exchange (SIMEX) and also in charge for the operation at back office to record the daily trading transactions. Normally, Nick Leeson would stay at SIMEX until trading closed at 2PM. After that, he would back to the office and record all the trading transactions for that particular day. Thus, he was the only one who knew about whether the recorded trading transactions were matched to the actual trading transactions. Besides, he was also the one who had given authority in cheque signing and sign off on trading reconciliation as well as responsible for vetting bank reconciliations. Obviously, there was conflict of interest between the two responsibilities, which would give rose to the operating risk. These two jobs supposed to be done by different people in order to mitigate or

34. reduce the risks of fraudulent activities happen. In order to mitigate risk, organization especially those involve in financial industry should review organizations internal control. Top management and internal auditors in an organization play an important role to ensure that segregation of duties is in place. No single employee can handle more than one crucial position in an organization especially those who dealing with financial and accounting information. This could help to safeguard company asset and produce more accurate information through reduce or mitigate the fraudulent risk. Indeed, management should understand that they have fiduciary duties towards the benefits for shareholders and company. Therefore, it is crucial for the management to know about the risks that might be faced in an organization. In short, in order to mitigate the risks, management cannot run away from giving proper supervision to the subordinates, understand the business nature and tighten up the internal control in an organization. Barings Banks case should be a great lesson to other organization especially financial industry entity. Negligence of external auditor The fall of Barings Bank was partly due to the negligence of the external auditor in performing their professional skills in auditing the Baring Future Singapore as well as the consolidated financial report in London Barings Bank. The reason could be the auditors themselves have lack of knowledge in derivatives trading and hence were incompetent to audit the financial performance of Barings Bank.

35. To improve or avoid the similar case from happening, the audit firms should always send their auditors to attend the professional courses to enhance their knowledge in order to increase their competencies in auditing companies that fall in different industries. Besides, the audit firms should have specialized skills auditors so they could be the expert in the particular industry to perform and oversee the audit work with due diligence care. By improving the auditors competencies, they will reduce the risk of negligent in performing audit work and finally may have avoided the fraud from happening. Corporate Governance In recent development of the corporate organizations, corporate governance is one terminology that has

continued to reflect in the internet, media, newspaper etc. The weak corporate management was exhibited by numerous well known organizations and has drawn so much attention. The issue of corporate governance was considered a global matter and the effect of inefficient corporate governance could lead to disaster since it affects the socio-economic and political lives. Basically, corporate governance could be defined as a set of processes, customs, policies, laws and institutions which can affect the direction of a corporation (way of being administered and being controlled). Corporate governance also covers the relationships among and between many stakeholders involved in operating a corporate organization and the establishment of goal. The failures of Barings Bank have created awareness and sensitivity among people related to the issue of corporate misdeeds. In fact, the collapse of Barings Bank (Britains oldest merchant, Queens bank and it had financed the Napoleonic Wars,

36. the Louisiana Purchase and the Erie Canal) was caused by the actions of a rogue trader at a small office in Singapore, Nick Leeson. Due to the lack of segregation of duties only, Nick Leeson could exploit the Barings Banks derivatives activities and totally wiped out the Barings Banks capital (around $1.4 billion) within almost four years of his working durations. The absence of the effective and efficient structure and objectives in the top management revealed the corporate governance failure of Baring Banks management. Consequently, the shareholders and stakeholders of Baring Bank were being affected deemed to the failure of the corporate governances management. As a result of the failures and lack of regulatory measures from authorities, the Committee of Sponsoring Organizations (COSO) was created. COSO is recognized the world over and providing guidance on critical aspects of organizational governance, business ethics, enterprise risk management, internal control, financial reporting and fraud. Beside, developments in the US arose debate in the UK and the scandals and collapses in UK in the late 1980s and early 1990s, led the shareholders and banks to worry about their investment Due to the events that led to the enhancement of corporate governance, it is crucial for an organization and being a fundamental requirement to well-conducted companies that could ensure they operate at optimum efficiency. The important attributes of corporate governance including: i. Ensure appropriateness and adequacy in the system of controls and hence asset may be safeguarded. ii. Prevents any single individual having too powerful on influencing people.

37. iii. Improve the relationship between a companys management, the board of directors, shareholders and stakeholders. iv. Ensure the company is being managed in the best interests of shareholders and stakeholders v. Encourage transparency and accountability Another important objective of corporate governance in an organization is the operational risk control. Operational risk was defined as the risk of loss through: i. Failure of systems ii. Deliberate conduct of staff iii. Negligent conduct of subordinates Holding massive of operational risk in a company may have systematic implications when the firms involve large investment with global operations. This was clearly proven by the Barings Banks collapse, in which resulted from senior managements failure to implement internal control producers for staff. Furthermore, the top management in Barings Bank also failed

to broader the issues of ensuring that the adequacy of complying the stated regulatory standards in all of its subsidiaries. What is clear from Barings Bank is that, home and host country regulators must communicate frequently and coordinate their investigations along the lines of international standards in order to supervising the multinational conglomerates.

38. What are the cases similar to Barings Bank? Societe Generale Particular: Socit Gnrale is the 3rd largest Corporate and Investment bank in the Eurozone by net banking income and the 6th largest French company by market capitalization. It employs 120,000 people, of which 75,000 in Europe, and maintains a presence in 80 countries.

39. Located at west of Paris Main divisions are Retail Banking & Specialized Financial Services (particularly in France and Eastern Europe), Corporate and Investment Banking (Derivatives, Structured Finance and Euro Capital Markets) and Global Investment Management & Services. Incidents: A single futures trader (Jrme Kerviel, a relatively junior futures trader) at the bank had fraudulently lost the bank 4.9billion (an equivalent of $7.2billionUS) A series of bogus transactions that spiraled out of control amid turbulent markets in 2007 and early 2008. Two credit rating agencies reduced the bank's long term debt ratings: from AA to AA- by Fitch; and from Aa1/B to Aa2/B- by Moody's (B and B- indicate the bank's financial strength ratings). Kerviel is exceeding his authority to engage in unauthorized trades totaling dealt with $73.3 billion (more than the bank's market capitalization of $52.6 billion) although bank officials claim that throughout 2007, Kerviel had been trading profitably in anticipation of falling market prices. According to the BBC, Kerviel generated 1.4 billion in hidden profits by the end of 2007. His employers say they uncovered unauthorized trading traced to Kerviel on January 19, 2008. The bank then closed out these positions over three days of trading beginning January 21, 2008, a period in which the market was experiencing a large drop in equity indices, and losses attributed are estimated at 4.9 billion. His trial began on June 8, 2010. He faces up to five years in prison and a

40. $450,000 fine. Similarity with Barings Differences with Barings Oldest banks in France Socit Gnrale does not collapse Single rogue trader with US bailout. Trader exceeded his authority Socit Gnrale has well Fraudulent trade that exist market established internal audit and risk capitalization. management. Greedy and desired of making Socit Gnrale operated in a profit for the bank. well establish regulatory system Fraud happened to cover losses. requirement because it happened on at later date (2007 & 2008). Undiscovered fraudulent trade method until the discovery of fraud perpetrated by Bernard Madoff. Bank of credit and commercial International (BCCI) Particular: BCCI was a major international bank founded in 1972 by Agha Hasan Abedi, a Pakistani financier. Registered in Luxembourg It operated in 78 countries, had over 400 branches, and had assets in excess of US$20 billion, making it the 7th largest private bank in the world by assets. Incidents: In the late 1980's BCCI became the target of a two-year undercover operation conducted by the US Customs Service. This operation concluded with a fake wedding that was attended by BCCI

41. officers and drug dealers from around the world who had established a personal friendship and working relationship with undercover Special Agent Robert Mazur. After a six month trial in Tampa, key bank officers were convicted and received lengthy prison sentences. Bank officers began cooperating with law enforcement authorities and that cooperation caused BCCIs many crimes to be revealed. BCCI became the focus of a massive regulatory battle in 1991 and was described as a "$20-billion-plus heist". Investigators in the U.S. and the UK revealed that BCCI had been "set up deliberately to avoid centralized regulatory review, and operated extensively in bank secrecy jurisdictions. Its affairs were extraordinarily complex. Its officers were sophisticated international bankers whose apparent objective was to keep their affairs secret, to commit fraud on a massive scale, and to avoid detection." Upon the shutdown of BCCI, 760 million loss incurred (100 million lost by UK local authorities). As a summary, monies laundered out of BCCI HQ bank in London through subsidiaries in fifteen countries by eight senior executives; BCCI shut down by Bank of England. Similarity with Barings Differences with Barings Collapse on fraudulent activities Do not expose to derivates trading. Escaped detection for longer period (20 years) BCCI adopt an opaque

42. international structure to fragment oversight and conceal activities from the regulators. More than single rogue trader involved. Happened before Barings Daiwa Bank Particular: 12th largest bank in Japan One of the country's top city banks Upon withdraw from all overseas banking operations; the bank now aims to concentrate on retail banking for small firms and individuals mainly in the Osaka region. On December 12, 2001 consolidation of Daiwa Bank, Kinki Osaka Bank, and Nara Bank as Daiwa Bank Holdings, Inc. After acquiring Asahi Bank on March 1, 2002, the company was renamed Resona Holdings, Inc. on October 1, 2002. Incidents: In 1995, one of Daiwa Bank's bond traders, Toshihide Iguchi, in New York lost $1.1 billion speculating in the bond market. The company was later indicted for not reporting crimes by Iguchi including selling unauthorized sale of client's securities to cover losses. Toshihide Iguchi had concealed more than 30 000 trades over 11 years starting

43. in 1984, in U.S. Treasury bonds. Consequently, Daiwa Bank shuts down global operations. Similarity with Barings Differences with Barings A trader had as Leeson - control Escaped detection for longer of both the front and back offices. period (11 years). Happened in the same year Do not involve derivates but bond (1995). market. Lack of internal control and risk Holding company does not management over global (far collapse after the incidents. west) subsidiaries. Metallgesellschaft Particular: Metallgesellschaft AG was formerly one of Germany's largest industrial conglomerates based in Frankfurt. It had over 20,000 employees and revenues in excess of 10 billion US dollars. It had over 250 subsidiaries specializing in mining, specialty chemicals (Chemetall), commodity trading, financial services, and engineering (Lurgi). Incidents: In 1993, the company lost over 1.4 billion dollars after speculating increase in oil price in oil futures market. A subsequent drop in oil price left the company buying the oil at a higher price than the market price. It is a mismatch between its derivates hedges and long-term oil contracts with customers. The company is now part of GEA

Group Aktiengesellschaft (from 2000 to 2005: mg technologies AG, before 2000: Metallgesellschaft). Similarity with Barings Differences with Barings

44. Loss incurred deal to derivates No rogue trader and fraudulent trading. case involved. Happened before Barings. Not a financial institution involved (An industrial company under the group). National Westminster Bank Plc (NatWest) Particular: A retail bank in the United Kingdom that has been part of The Royal Bank of Scotland Group Plc since 2000. Established in 1968 by the merger of National Provincial Bank (established 1833 as National Provincial Bank of England) and Westminster Bank (established 1834 as London County and Westminster Bank). Traditionally considered one of the Big Four clearing banks, NatWest has a large network of 1,600 branches and 3,400 cash machines across Great Britain and offers 24-hour Actionline telephone and online banking services. Today it has more than 7.5 million personal customers and 850,000 small business accounts. Incidents: In 1997, NatWest Markets, the corporate and investment banking arm formed in 1992, revealed a 50m loss had been discovered in its interest rate options and swaps trading books, escalating to 90.5m after further investigations. NatWest Markets troubles started with a systematic mispricing of various options and swaps by traders in its rate risk management group. As losses mounted, Kyriacos Papouis, who traded Deutschemark (DEM) interest rate options and swaps, began to mismark options positions in the banks books in

45. a concerted attempt to cover up the losses. His supervisor, Neil Dodgson, who traded Sterling (GBP) interest rate options and swaps, also mismarked positions. Investor and shareholder confidence was so badly shaken that the Bank of England had to instruct the board of directors to resist calls for the resignation of its most senior executives in an effort to draw a line under the affair. By the end of 1997 parts of NatWest Markets had been sold, others becoming Greenwich NatWest in 1998. Similarity with Barings Differences with Barings Internal controls and risk More than one trader involved. management were severely Does not collapse after the criticized. incident. Poor management by looking at Happened after Barings. bank's move into complicated Longer detection period than derivative products that it did not Barings. fully understand. Fraud happened to cover losses.

46. What regulation has been imposed in response to the collapse of Barings Bank? The sudden collapse of the Barings Bank brought to the sharp focus the need of regulators to examine the problems and take concrete actions to deal with the problems to safeguard the same case from happening again in the future. Following the collapse of Barings Bank, regulatory authorities from sixteen countries, who have oversight the worlds major futures and options market, met at Windsor, to attend the meeting hosted by the United Kingdom Securities and Investments Board and the United States Commodity Futures Trading Commission to discuss the key issues resulting from the failure of Barings Bank and the ways to strengthen supervision, minimized systematic risk and disruptions. In the Windsor Declaration, the regulatory authorities addressed the issues related to: Cooperation between market authorities Protection of customer positions, funds and assets Default procedures Regulatory cooperation in emergencies. Cooperation between market authorities The regular authorities agreed to improve

cooperation and communications of information relevant to material exposures and other regulatory concerns between regulators and market authorities. The reason is an individual regulator or market authority alone may not have information on all material exposures of market

47. members and consequently communications could help to minimize the effect of market disruption caused by failures and bankruptcy. If there is a communication between the regulators in United Kingdom, Japan and Singapore which if they have sufficient regulatory oversight on the derivatives trading by Nick Leeson, the oldest bank in England would have been survived. Protection of customer positions, funds and assets The regulator authorities will review the adequacy of existing arrangements and enhance the arrangements appropriately to minimize the risk of loss through insolvency and misappropriate use of assets. Default procedures The regulator authorities will promote and facilitate the liquidation or transfer of positions, funds, and assets from the failing members of future exchanges to mitigate the risk of losses due to the inability of the solvent participants in managing the exposures to a failing market member. Regulatory cooperation in emergencies The regulator authorities will enhance the emergency procedures and improve the effectiveness of international co-ordination and timely communication of reliable information which is needed in supervisory purpose when the market is in difficulties. In addition, the Windsor Declaration requires the authorities to promote the following issues: (retrieved from U.S. Commodity Futures Trading Commission)

48. Development of mechanisms to ensure that customer positions, funds and assets can be separately identified and held safe to the maximum extent possible and in accordance with national law. Enhanced disclosure by the markets of the different types and levels of protection of customer funds and assets which may prevail, particularly when they are transferred to different jurisdictions, including through omnibus accounts. Record-keeping systems at exchanges and clearing houses and/or market members which ensure that positions, funds and assets to be treated as belonging to customers can be satisfactorily distinguished from other positions, funds and assets. Enhanced disclosure by markets to participants of the rules and procedures governing what constitutes a default and the treatment of positions, funds and assets of member firms and their clients in the event of such a default. The immediate designation by each regulator of a contact point for receiving information or providing other assistance to other regulators and/or market authorities and the means to assure twenty-four hour availability of contact personnel in the event of disruption occurring at a financial intermediary, market member or market. In short, sufficient regulatory oversight and communication as well as cooperation between the market authorities are essential to avoid the similar case like Barings Bank from happening. This could be done more effectively through the enforcement of regulations or the enforcement of resolutions by an international body.

49. Conclusion The collapse of Barings Bank may have not greatly impacted the regulators and the banks to form a new regulation but it would be a great lesson for the companies and banks all over the world to understand the importance of proper

supervision and control systems and pay more attention on the issues of corporate governance and risk management.