The Collapse of Barings

Finance 443International Finance

Jay YooAlan Yeung

Stuart SuttonJennie Kretchmar

Contents Background of Barings Nicholas Leeson How Leeson Broke Barings Barings Inadequate Controls

Background of Barings Founded in 1762.

Rapid growth during Napoleonic Wars (1798 – 1814)

Concurred as the sixth great European power at the Congress of Vienna in 1815

During the years of 1830s and 1840s, Barings became the most influential financial house in U.S.

Background of Barings A Financial Crisis in 1890

Provided loans to Argentina in 1824

Debt crisis in Argentina in 1888

Reported company’s liabilities of over 21 million pounds sterling

Rescued by the British government and the Bank of England

Background of Barings Impact of Argentine Debt Crisis

Withdrew all transaction in North American continent

Firm’s management was relegated to consulting small firms and wealthy people, which includes British Royal family

Background of Barings Repair of Company’s Reputation

Success in consulting the royal family asset management

Success in giving advice for stock and bonds for small British firms

Moved back into American finance scene in 1980s

Background of Barings Expansion to Asia

Opened a stock brokerage operation in Tokyo during the mid 1980s

Expanded its operation by establishing offices in Singapore

Background of Barings Leeson Crisis in 1995

Nick Leeson, a lone manager in the company’s Singapore office made speculative trades on future market, which broke the company

ING, Dutch financial service company, bought Barings at the fire sale price of just £1 in June 1995

Nicholas Leeson The son of a plasterer from the London suburb of Watford

Described as a loner by the people that he worked with

Competent soccer player

Nicholas Leeson 28-year-old trader who never graduated

from college

Gained knowledge through numerous investment establishment positions

Nicholas Leeson An investment officer at Barings L.P.C.

Working at the Singapore International Monetary Exchange

In charge of both making deals and overseeing the paperwork on these deals

Nicholas Leeson Accused of losing the $1.3 billion

Charged with forgery and cheating on December 1, 1995

Sentenced to six and a half years

How Leeson Broke Barings? Arrived in Singapore in 1992

Arbitrage opportunities of Nikkei 225 futures between SIMEX and OSE

Leeson’s Singapore office is terribly understaffed – errors frequently occurred

Error account “88888” created by a new phone clerk: Loss of £20,000

How Leeson Broke Barings? Unauthorized: Sold options, took positions

on SIMEX on both futures and options contracts

Fantasy: Leeson is a genius – Created 50% of Barings’ 1994 profits

Reality: Leeson is a loser – Loss of $296 million in 1994 alone

How Leeson Broke Barings? How did he do that?

Cross-trade technique with a real account “92000” and the error account “88888”

In November and December 1994 Sold 34,400 options (straddles)

Year Reported (Million) Actual (Million)

1993 +£ 8.83 -£ 21

1994 +£ 28.53 -£ 185

1995 +£ 18.57 -£ 619

How Leeson Broke Barings?

Straddles: Profitable (Premium) if Nikkei traded

within or near strikes between 18,500 – 20,000

How Leeson Broke Barings?

4Q 1994 - January 1995 Nikkei in a range of 19,000 – 19,500 Leeson held long futures of 3,000 Nikkei

225 equity contracts

Nikkei 225日経平均株価

How Leeson Broke Barings?

January 17, 1995 Kobe Earthquake Nikkei dropped sharply as people took cash out

How Leeson Broke Barings?

January 20 – February, 1995 Leeson launched aggressive buying

program: (3,000) 55,206 March contracts and 5,650 June contracts

How Leeson Broke Barings?

Barings collapsed – could not meet huge trading obligations

Outstanding futures positions of $27 billion (Barings’ capital was $615 million)

Barings Inadequate Controls

Lesson controlled both the dealing desk and the back office

Leeson removed account “88888” from daily accounts sent to Barings

Barings ignored internal auditor’s reports

Barings Inadequate Controls Problems with Senior management

Showed little interest in the Singapore Branch

Had only a vague understanding of derivatives

Did not have a precise breakdown of Leeson’s profits

Failed to question capital requests by Leeson to fund margin accounts

Barings Inadequate Controls Problems with Barings Funding

Control Measures

No distinction between proprietary and customer trades

Ignorance to credit risks

Barings Inadequate Controls Supervision Problems

Leeson’s superiors did not accept responsibility over him

No one investigated a default in account “88888”

Conclusion Barings collapse could have been prevented

through a series of controls to monitor Leeson

Why couldn’t others duplicate Leeson’s strategy

Any Questions?