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ARTICLE 1 Barings Bank (1762 to 1995) was the oldest merchant banking company in London, England  until its collapse in 1995 after one of the bank's employees, Nick Leeson, lost $1.4 billion in speculation primarily on futures contracts.
Barings Bank was founded in 1762 as the 'John and Francis Baring Company' by Sir Francis Baring. In 1806 his son Alexander Baring joined the firm and they renamed it Baring Brothers & Co., merging it with the London offices of Hope & Co., where Alexander worked with Henry Hope. Barings had a long and storied history. In 1802, it helped finance the Louisiana Purchase, despite the fact that Britain was at war with France, and the sale had the effect of financing Napoleon's war effort. Technically the United States did not purchase Louisiana from Napoleon. Louisiana was purchased from the Baring brothers and Hope & Co.. The payment for the purchase was made in US bonds, which Napoleon sold to Barings at a discount of 87 1/2 per each $100. As a result, Napoleon received only $8,831,250 in cash for Louisiana. Alexander Baring, working for Hope & Co., conferred with the French Director of the Public Treasury François Barbé-Marbois in Paris, went to the United States to pick up the bonds and took them to France. Later daring efforts in underwriting got the firm into serious trouble through overexposure to Argentine and Uruguayan debt, and the bank had to be rescued by a consortium organized by the governor of the Bank of England, William Lidderdale, in the Panic of 1890. While recovery from this incident was swift, it destroyed the company's former bravado. Its new, restrained manner made it a more appropriate representative of the British establishment, and the company established ties with King George V, beginning a close relationship with the British monarchy that would endure until Barings' collapse. The descendants of the original five male branches of the Baring family were all appointed to the peerage with the titles Baron Revelstoke, Earl of Northbrook, Baron Ashburton, Baron Howick of Glendale and Earl of Cromer. The company's restraint during this period would cost it its preeminence in the world of finance, but would later pay dividends when its refusal to take a chance on financing Germany's recovery from World War I saved it the painful losses experienced by other British banks at the onset of the Great Depression.
Events leading to Barings Bank's collapse
Barings Bank's activities in Singapore between 1992 and 1995 enabled Nick Leeson to operate effectively without supervision from Barings Bank in London. Leeson acted both as head of settlement operations (charged with ensuring accurate accounting) and as floor manager for Barings' trading on Singapore International Monetary Exchange, or SIMEX. This placed Leeson in the position of reporting to an office inside Barings Bank which he himself held. Because of the absence of oversight, Leeson was able to make seemingly small gambles in the futures market and cover for his shortfalls by reporting losses as gains to Barings in London. Specifically, Leeson altered the branch's error account, subsequently known by its account number 88888 as the "five-eights account", to prevent the London office from receiving the standard daily reports on trading, price, and status. Using the hidden "five-eights account," Leeson began to aggressively trade in futures and options on SIMEX. His decisions routinely lost substantial sums, but he used money entrusted to the bank by
Nick Leeson wrote an autobiography. covering the events leading up to the collapse. After two years of steady losses covered up by the unknown "fiveeights" error account. Barings Bank management in London at first congratulated and rewarded Leeson for what seemed to be his outstanding trading profits. . entitled Rogue Trader. He falsifed trading records in the bank's computer systems. Barings collapsed on February 26. Nick Leeson's activities had generated losses totaling £830 million.subsidiaries for use in their own accounts. but it was too late. Barings Bank therefore no longer has a separate corporate existence. BAM was split and sold by ING to MassMutual and Northern Trust in March 2005. Barings Bank auditors finally discovered the fraud. 1995 Barings was purchased by the Dutch bank/insurance company ING for the nominal sum of £1 along with assumption of all of Barings liabilities. although the Barings name still lived on as Baring Asset Management. and used money intended for margin payments on other trading. it was dramatised in the movie Rogue Trader.
or directional bets on a market. Leeson’s experience with trading was limited. Nick Leeson grew up in London’s Watford suburb. Founded in 1762. the 28-year-old Nick Leeson promptly started unauthorized speculation in futures on Nikkei 225 stock index and Japanese government bonds (Risk Glossary). Nick Leeson enhanced his reputation within Barings when he successfully rectified the situation in 10 months (Risk Glossary). Nick Leeson oversaw both trading and back office functions. while not providing any individual who was directly responsible for monitoring Leeson’s trading activities (eRisk). Transacting futures and options orders for clients or for other firms within the Barings organization. Nick Leeson was transferred to Barings Securities in Singapore and was promoted to general manager. a stark contrast to the relatively conservative arbitrage that Barings had intended for Leeson. after his initial success. Barings was brought to its knees by a rogue trader in a Singapore office. The trader. and 2. Barings’ senior management came from a merchant banking background. causing them to underestimate the risks involved with trading. In addition. one man single-handedly bankrupted the bank that financed the Napoleonic Wars. eliminating the necessary checks and balances usually found within trading organizations. Aided by his lack of supervision. Arbitrage is an inherently low risk strategy and was intended for Leeson and his team to garner a series of small profits. Arbitraging price differences between Nikkei futures traded on the SIMEX and Japan's Osaka exchange.4 billion hole in Barings’ balance sheet due to his unauthorized derivatives speculation. causing the 233-year-old bank’s demise. Louisiana Purchase and the Erie Canal. Shortly after. A scandal ensued when Leeson left a $1. In 1992. These trades were outright trades. but he took an exam that qualified him to trade on the Singapore Mercantile Exchange (SIMEX) alongside his traders. Nick Leeson. Nick Leeson opened a secret trading account numbered 88888 to facilitate his furtive trading.ARTICLE 2 The Collapse of Barings Bank In February of 1995. Indonesia to sort through back-office mess involving £100 million of share certificates. According to Risk Glossary: "Leeson and his traders had authority to perform two types of trading: 1. and worked for Morgan Stanley after graduating university. was employed by Barings to profit from low risk arbitrage opportunities between derivatives contracts on the Singapore Mercantile Exchange and Japan’s Osaka Exchange. Barings Bank was Britain’s oldest merchant bank and Queen Elizabeth’s personal bank. with the authority to hire traders and back office staff. Risk Glossary says of Leeson: . rather than spectacular gains. Once a behemoth in the banking industry. This highly leveraged strategy can provide fantastic gains or utterly devastating losses. Leeson joined Barings and was transferred to Jakarta." As a general manager.
4 billion. In this case.” The horrific losses accrued by Nick Leeson were due to his financial gambling. Barings’ senior management had discovered Nick Leeson’s elaborate scheme. Prior to 1995. he just made consistently bad bets. If he hadn't been so misfortunate. Nick Leeson suffered monumental losses as the market continued its descent. A year later. Leeson had extremely bad luck. he had accumulated an enormous position—half the open interest in the Nikkei future and 85% of the open interest in the JGB [Japanese Government Bond] future. or $1. according to “How Leeson Broke the Bank. most established bank was unable to meet SIMEX’s margin call. After the collapse of Barings. After a series of lies. dropping the Nikkei 1000 points while pulling Barings even further into the red. however. the 88888 account was under water by about GBP 2MM. Leeson lived the life of a high roller. as he placed his trades based upon his emotions rather than by taking calculated risks. Derivatives can be tremendously useful if used for hedging and controlling risk or even careful trading. As an inexperienced trader. however. 1995. and while imprisoned. decrying the use of derivatives. ING. Leeson and his wife were arrested in Frankfurt. The fact that he was so unlucky shouldn't be too much of a surprise. Nick Leeson was reckless and dishonest. Malaysia. purchased Barings for a mere £1 and assumed all of its liabilities (eRisk). England’s oldest. He survived his cancer. the Dutch bank. a worldwide outrage ensued. Leeson frantically purchased even more Nikkei futures contracts in hopes to gain back the money already lost. In January 1995. are quick to admit their mistakes and cut losses. Leeson and his wife fled Singapore for Kuala Lumpur. He was sentenced to six and a half years in a Singaporean prison. Leeson's 88888 account had lost a total of GBP 208MM. securing his reputation as a star trader and gaining bonuses for Barings’ employees (Risk Glossary). The most successful traders. Barings management remained blithely unaware. we probably wouldn't have ever heard of him.He lost money from the beginning. is that derivatives are only as dangerous as the hands they are placed in. That same day.000 on his salary of £50. The total damage suffered by Barings was £827 million. Nick Leeson . detailing his role in the Barings scandal. The market was aware of this and probably traded against him. Betting on the recovery of the Japanese stock market. cover ups and falsified documents. this had mushroomed to GBP 23MM. In 1994. while he posted profits in other trading accounts. Surprisingly. a powerful earthquake shook Japan.000 per month apartment and earning a bonus of £130.55 million in false profits. By then. however. where he contracted cancer (Risk Glossary). Increasing his bets only made him lose more money. By the end of 1992. In February 1995. By the end of 1994. By mid February 1995. and was declared bankrupt. Nick Leeson was placed on trial in Singapore and was convicted of fraud. complete with his $9. Nick Leeson effectively managed to avert suspicion from senior management through his sly use of account number 88888 for hiding losses.000. wrote an autobiography called “Rogue Trader”. The truth. Despite the staggering secret losses. “Rogue Trader” was eventually made into a movie of the same name. Leeson fabricated £28. Germany on March 3rd . As a trader.
094 contracts reached about a month later. Leeson sold 70. 1995. This arbitrage. required Leeson to buy the cheaper contract and to sell simultaneously the more expensive one. Because Leeson's official trading strategy was to take advantage of temporary price differences between the SIMEX and OSE Nikkei 225 contracts. Britain's oldest merchant bank. If Leeson was long on the OSE. their enormity is all the more astounding when compared with the banks reported capital of about $615 million.000.500 to 20. Leeson sold straddles. But Leeson was not short on SIMEX. Article 3 Unlearnt lessons from Barings The derivative trading is not as easy as perceived. The build-up of the Nikkei positions took off after the Kobe earthquake of January 17.68 bn.000 if he was to make money on his option trades. Leeson's positions went in the opposite direction to the Nikkei . This kind of arbitrage activity has little market risk as the positions were always matched. which Leeson established in the name of the bank. Such trades are very profitable provided the Nikkei 225 is trading at the options' strike on expiry date since both the puts and calls would expire worthless. He thus needed the Nikkei 225 to continue to trade in its pre-Kobe earthquake range of 19. the Nikkei 225 was at 19. These were unauthorised trades which he hid in an account named Error Account 88888. In industry parlance. A few days after the earthquake. The chain of events which led to the collapse of Barings. he had to be short twice the number of contracts on SIMEX. it could still be profitable because the earned premium more than offsets the small loss experienced on either the call (if the Tokyo market had risen) or the put (if the Nikkei had fallen).as the Japanese stock market fell. is a demonstration of how not to manage a derivatives operation.was released from prison in July 1999 for good behavior.350. Barings collapsed as it could not meet the enormous trading obligations. If the Nikkei is trading near the options' strike on expiry. Leeson started an aggressive buying programme which culminated in a high of 19.000 . Here is a case which shows the instincts of how risky the business is. But Leeson's Osaka position reflected only half of his sanctioned trades. The strike prices of most of Leeson's straddle positions ranged from 18. When it went into receivership on February 27. i.000 contracts on the Osaka Stock Exchange. It ended that week . On the day of the quake. He also used this account to execute all his unauthorised trades in Japanese Government Bond and Euroyen futures and Nikkei 225 options: together these trades were so large that they ultimately broke Barings. he sold put and call options with the same strikes and maturities.892 Nikkei 225 options worth about $7 bn without the knowledge of Barings London. 1995.e.500. The Kobe earthquake shattered Leeson's options strategy.000 to 19.000 straddles over a fourteen month period. 892 Nikkei put and call options with a nominal value of $6. The most striking point is the fact that Leeson sold 70. infact he was long approximately the number of contracts he was supposed to be short. The nominal size of these positions is breathtaking. Barings had outstanding notional futures positions on Japanese equities and interest rates of US$27 billion: US$7 bn on the Nikkei 225 equity contract and US$20 bn on Japanese government bond (JGB) and Euroyen contracts. The control and risk management lessons to be learnt from this collapse apply as much to cash positions as they do to derivative ones. reversing the trade when the price difference had narrowed or disappeared. Leeson earned premium income from selling well over 37. Before the earthquake. January 17. The activities of Nick Leeson on the Japanese and Singapore futures exchanges led to the downfall of Barings. Leeson had long futures positions of approximately 3. The leverage and liquidity offered by futures contracts brings down an institution with lightning speed which is in contrast to bad loans or cash investments whose illeffects takes years to ruin an institution. which Barings called 'switching'. Nikkei traded in a range of 19.20.
If a Member has matching buy and sell orders from two different customer accounts for the same contract and at the same price. Leeson entered into a significant volume of cross transactions between account '88888' and account '92000' (Barings Securities Japan . A cross trade is a transaction executed on the floor of an Exchange by just one Member who is both buyer and seller. After executing these cross-trades. Leeson bought from one hand and sold to the other. Leeson found himself showing losses on his two-day old long futures position and facing unlimited damage from selling put options. This is tantamount to allowing the person who works a cash-till to bank in the day's takings without an independent third party checking whether the amount banked it at the end of the day reconciles with the till receipts. Some back offices also provide the regulatory reports and management accounting. The call options Leeson sold looked worthless but the put options became very valuable to their buyers if the Nikkei continued to decline.Nikkei and JGB Arbitrage). confirms and settles trades transacted by the front office. account '98007' (Barings London . Leeson. his bosses thought he made them US$46 million.950 on January 23.206 March 1995 contracts and 5640 June 1995 contracts. Leeson's losses on these puts were unlimited and totally dependent on the level of the Nikkei at expiry.they effectively let Leeson settle his own trades by putting him in charge of both the dealing desk and the back office. It was the profit and loss statement of this account which correctly represented the revenue earned (or not earned) by Leeson. so they proposed paying him a bonus of US$720. reconciles them with details sent by the bank's counterparties and assesses the accuracy of prices used for its internal valuations. the back office . reflected pairs of transactions adding up to the same number of lots at prices bearing no relation to those executed on the floor. the books and records of BFS.trade must be executed at market-price. Yet he was perceived in London as the wonder boy and turbo-arbitrageur who single-handedly contributed to half of Barings Singapore's 1993 profits and half of the entire firm's 1994 profits. The bottom line of all these cross-trades was that Barings was counterparty to many of its own trades. The management of Barings broke a cardinal rule of any trading operation . On 27 January.950 so Leeson's straddle positions started to look shaky. and to change the trade prices thereon to cause profits to be credited to 'switching' accounts referred to above and losses to be charged to account '88888'. Leeson instructed the settlements staff to break down the total number of contracts into several different trades. Leeson lost Barings US$296 million. In 1994 alone.handedly to reverse the negative post-Kobe sentiment that swamped the Japanese stock market. which were buried in account '88888'. It also accepts/releases securities and payments for trades.Euroyen Arbitrage). and in so doing did not lay off any of the firm's market risk. Leeson doubled this long position to reach a high on 22nd February of 55. He took proprietary positions on SIMEX on both futures and options contracts. a settlement system used extensively by SIMEX members. 1995. Thus while the cross trades on the Exchange appeared on the face of it to be genuine and within the rules of the Exchange. tried single.000.158 March 1995 contracts. A cross. he is allowed to cross the transaction (execute the deal) by matching both his client accounts. while the profits on the calls were limited to the premium earned. When the Nikkei dropped 1000 points to 17. Details of this account were never transmitted to the treasury or risk control offices in London. In a nutshell. The back-office records. account '88888' showed a long position of 27. Leeson lost money from his unauthorised trades almost from day one. an omission which ultimately had catastrophic consequences for Barings shareholders and bondholders.slightly lower at 18. Barings was thus not arbitraging between SIMEX and the Japanese exchanges but taking open (and very substantial) positions. maintained in the Contac system. Over the next three weeks. How was Leeson able to deceive everyone around him? How was he able to post profits on his 'switching' activity when he was actually losing? The vehicle used to effect this deception was the cross trade. Leeson was also engaged in unauthorised activities almost when he started trading in Singapore in 1992.JGB Arbitrage) and account '98008' (Barings London .
Contingency Analysis. Rogue Trader 1999 film starring Ewan McGregor.bbc. Since Leeson was in charge of the back office. Nick Leeson Official Website of the Barings Rogue Trader http://www. eRisk. <http://www. Links to other Barings Bank Collapse Pages Risk Glossary: Nick Leeson and Barings Bank eRisk: Barings Case Study References: "Barings Case Study.co. accounting entries and position reports. Thus Leeson was considered perfectly placed to relay false information back to London. British Broadcasting Company. 12 March 2005. he had the final say on payments. 12 March 2005. Rogue Trader (1996.nytimes. June 22.html . "High Speed Money".stm> "Nick Leeson and Barings Bank. Book by Nick Leeson giving his account of the Barings Bank collapse.com. ingoing and outgoing confirmations and contracts.numa.com/Learning/CaseStudies/ref_case_barings. a movie about the bank the broker Leeson. February 2004. January 1996.com/ref/barings/ http://www. <http://www." eRisk.uk/2/hi/business/375259. (1997.asp> “How Leeson Broke the Bank.com/books/first/f/fay-collapse. 1999.riskglossary.htm See also • • • • • • • Leonard Ingrams. hardcover) ISBN 0-316-51856-5. reconciliation statements. former Managing Director and founder of Garsington Opera. <http://news. 12 March 2005.provides the necessary checks to prevent unauthorised trading and minimise the potential for fraud and embezzlement.” BBC Online." RiskGlossary.erisk.com/articles/barings_debacle. softcover) ISBN 0-7515-17089.com.
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