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What was Nick Leeson’s strategy to earn trading profits

on derivatives?
-> He was speculating wildly and completely without
authorization, in massive amounts on movements in the Japanese
stock and bond markets.
-> Most of his trading was a bet on the volatility of the Tokyo
stock and bond markets. In his futures positions, he was betting
that the Tokyo stock market would rise and the bond market would
-> Leeson’s trading activities mainly involved three futures
markets: Futures on the Japanese Nikkei 225 stock index, futures
on 10-year Japanese Government bonds (JGB futures) and
European futures.
-> Leeson executed a trading strategy known as a "straddle," with
the objective of making a profit by selling put and call options on
the same underlying financial instrument, in this case, the Nikkei
225 Index. A straddle will generally produce positive earnings
when markets are stable but can result in large losses if markets are
-> He planned his strategy taking into consideration the Japanese
futures market as in Japan the margin is posted on a net basis for
all costumers and if there are customers who are in short position,
firm can take long position without any need to pay the call
margin. He utilized this opportunity through his bogus erroe
account 88888 and companies account 99002.

Q2. What went wrong that caused his strategy to fail?

-> Nick Leeson’s strategy failed as he was taking into
consideration that market has experienced an extended bull run
throughout the late 1980¶s and after that it has fallen to half of its
1989 high and he was thinking that it has fallen enough and from
now it will only go up and second thing he thought is that the
interest rates are also low at the moment and if they are going to
rise they will hurt him as more of the investors will move towards
the safe earning through the high interest rate returns making the
investment into market to reduce and hence to make himself on the
safer side he invested into government bonds futures.
-> Nick Leeson’s strategy failed because the Nikkei 225 index kept
falling while he continued to bet that it would rise ± he just didn’t
know when to quit and take his losses. Leeson increased the size of
his open positions even as his losses increased due to volatility in
the markets. He did nothing to hedge his position - to lay off his
potential losses if the markets did move the wrong way. In effect,
Leeson was accepting unlimited liability.
-> Also, he was relying on the bank interest rate that it would
decrease but eventually the exact opposite thing happened and the
interest rate increased to a high.

Q3. Why did Nick Leeson establish a bogus error account

(88888) when a legitimate account (99002) already existed?
-> Nick Leeson established a bogus error account (88888) when a
legitimate account (99002) already existed in order to hide his
unauthorized trading activities.
-> While the legitimate error account was known to Barings
Securities in London, the bogus account was not.
-> It was a loophole he exploited to set up bogus accounts for non-
existent clients to mask mounting debts.
-> This account enabled Leeson to take advantage of the rules of
Japanese Futures market at that time. In Japan margin was posted
on net basis for all customers. Therefore if many customers were
short index futures, the firm can take long position without having
to post cash margin.
Q4. Why did Barings and its auditors not discover that the
error account was used by Leeson for unauthorized trading?
-> Barings and its auditors were unable to discover that the error
account was used by Leeson for unauthorized trading as the
account did not show on files or statements transmitted from
Singapore to London. There was no clue from which they have
gained any information about the existence of this account.
-> Moreover this account was known to SIMEX as a customer
account rather than a error account.
-> There was no proper segregation between front and back office
as both were under the control of leeson so making it easier for
him to keep tracking and modifying the contents as per his
utilization so that his own activities keep going without any
-> Also, Leeson was able to do this due to the nature of japanese
future market at that time. As the exchange there did not require a
separation between customer and the proprietary funds and hence
making it difficult to differentiate between the funds and the
position of the firm and the customer.

Q5. Why did none of the regulatory authorities in Singapore,

Japan, and the United Kingdom not discover the true use of
the error account?
-> Nick Leeson was clever and adept enough to hide the true cause
of the use of the error account 88888. None of the regulatory
authorities in Singapore, Japan and U.K was able to discover the
true use of error account as it was visible to them as a customer
-> The speculative position of Barings was hidden due to use of a
bogus account to clear trades. With a bogus account, the identity of
the broker’s customers is hidden from the exchange and the
-> The other reason was the solo-consolidation of Baring
Securities Ltd and Baring Brothers & Co. This allowed them to be
treated as one entity for capital adequacy and large exposure
purposes. This meant Leeson had access to a larger amount of
Q6. Why was Barings Bank willing to transfer large cash sums
to Barings Futures Singapore?
Barings Bank believed that the large cash sums transferred to
Barings Futures Singapore was for loans to customers as portrayed
on the Barings Futures Singapore balance sheet. The key aspect of
Japanese Future market was that exchange did not require a
separation between customer and propriety funds. Therefore it was
impossible to distinguish between the firm's and the customer

Q7. Why did the attempt by the Bank of England to organize a

bailout for Barings fail?
The attempt by the Bank of England to organize a bailout for
Barings failed because no one would assume the contingent risk of
additional, but as yet undiscovered losses. Bank of London made a
huge effort to organize a bailout for Barings bank. The bailout
failed because Barings bank reached to the position where losses
amounted more than the double the capitalization of the bank.
Further losses were inevitable and thus there was no one ready to
assume the contingent risk of additional but yet undiscovered
losses. The bank was trapped in such a situation that the amount of
future losses was unknown and unrevealed due to the unauthorized
dealing by Nick Leeson.
Q8. Suggest regulatory and management reforms that might
prevent a future debacle of the type that bankrupted Barings.
-> Management teams have a duty to understand fully the
businesses they manage

-> Responsibility for each business activity has to be clearly
established and communicated.
-> Clear segregation of duties is fundamental to any effective
control system.
y Relevant internal controls, including
independent risk management, have to be established for all
business activities.

-> Top management and the Audit Committee have to ensure that
significant weaknesses, identified to them by internal audit or
otherwise, are resolved quickly.

-> Understanding of the Business: Top management should
understand the business they are dealing in. For example in the
present case Leeson was reporting huge profits but Arbitraging is a
low risk and hence low profit business so how was he reporting
such huge profits. Thus it is very necessary that management has
sufficient knowledge and should be adept enough to understand the
complexities of business and its fundamental concept.
-> Lack of internal checks and balances: The power given to the
Lesson was uneven just because of his knowledge and no inquiry
was done on the trading lesson was doing just because the
company was running in profit.

-> If Barings' auditors and top management had understood the

trading business, they would have realised that it was not possible
for Leeson to be making the profits that he was reporting without
taking on undue risk, and they might have questioned where the
money was coming from.
-> Poor supervision of employees: Although Leeson had never
held a trading license prior to his arrival in Singapore, there was
little oversight of his activities and no individual was directly
responsible for monitoring his trading strategies.
-> Lack of a clear reporting line: Leeson's fraud may have been
facilitated by the confusion caused by two reporting lines: one to
London, for proprietary trading, and another to Tokyo for trading
on behalf of customers.