The Collapse of Barings

Finance 443 International Finance

Jay Yoo Alan Yeung Stuart Sutton Jennie 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 companys 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 Firms management was relegated to consulting small firms and wealthy people, which includes British Royal family

Background of Barings

Repair of Companys 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, alone manager in the companys 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 Leesons 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
Year 1993 1994 1995 Reported (Million) Actual (Million) + 8.83 + 28.53 + 18.57 - 21 - 185 - 619

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

How Leeson Broke Barings?

Straddles: Profitable (Premium) if Nikkei traded within or near strikes between 18,500 20,000

How Leeson Broke Barings?

Nikkei 225

4Q 1994 - January 1995 Nikkei in a range of 19,000 19,500 Leeson held long futures of 3,000 Nikkei 225 equity contracts

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 auditors 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 Leesons 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

Leesons 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 couldnt others duplicate Leesons strategy

Any Questions?