baring bank-rogue trader

Group Members:KOK KEAN TEONG

CEA070059MOH JIA WEI CEA070084NEO CHING HUP

CEA070109ONG KAH HOEY

CEA070157TEO SILK KEONG

CEA070197

Nicholas Leeson and Barings Bank

CAEA 3231 Integrated Case StudyFaculty of Business and Accountancy

What is derivative trading?An agreement between two different parties which the value of the instrument is determined by contingent future outcome of particular underlying factors.

Types of Derivatives Market

Over-The-Counter derivative market (OTC)

Exchange-Traded derivative market (ETD)

Privately negotiated

Fulfill the need of both side

Largely unregulated market

Over-The-Counter derivative market (OTC)

Exchange-Traded derivative market (ETD)

Standardized contracts

Acts as an intermediary

Provides information of the trading

Example: Chicago Board of Trade, Chicago Mercantile Exchange, Korea Exchange

Types of Common Derivative Contracts

Purposes of Investing In Derivative MarketTo speculate and make profit due to the changes of the value of the underlying assets.

To exposure to underlying asset which it is not possible to trade in the underlying asset market.

What is the role of investment bank in derivative trading

Act as agent in derivative trading

Creating derivative contracts

Provide advisory services

Performing risk management - clearing-house

Compliance with the exchanges’ rule and regulation

Perform trade confirmation

Established in London in 1763

Britain oldest Merchant Bank

Leading Merchant Bank

By 1989-established trading operations

February 1995-discovered huge fraud scheme

Barings Bank

Son of a working class plasterer from a Watford council estate

Worked as a clerk with Royal Bank Coutts

Spent two years at Morgan Stanley

In 1989-joined Baring Securities Ltd (BSL)

First quarter of 1992-posted to Baring Futures Singapore Ltd (BFS)

Be a unauthorized speculative trades that at first made large profits for Barings

He earned a bonus of £130,000 on his salary of £50,000 in 1992

Sent Barings Bank to bankruptcy

Nick Leeson

Brief Story- Barings BankIn 1992, Nick Leeson went to Barings Bank' Singapore office

Responsible for derivative trading of Singapore and Japan

Nikkei 225 contract traded on SIMEX and OSE

10 –year JGB (Japanese government bonds) contract dealt in SIMEX and OSE.

3-month Euroyen contract dealt in SIMEX and TIFFE (Tokyo Financial Futures Exchange) in the Japan.

Derivative trading strategy

Inter-exchange arbitrate strategy

“Straddle” strategy

Brief Story- Barings Bank

What was the strategy being implemented by Nick Leeson as required by Baring Bank management ?

Buy and sell Nikkei

225 futures

contracts simultane

ously

Gain the

arbitrate

profit

Inter-exchange arbitrate strategy

What was the strategy being implemented by Nick Leeson to gain more profit ?

“Straddle” strategy

In 1992, suffering first loss of $20,000

Create error account –account “88888”

In 20 January 1995, Nick Leeson decided to double up the long position to 55,206 March 1995 and 5,640 June 1995 contracts


Is the Nikkei 225 Index is a stable financial instrument?

Performance of Nikkei 225 after Kobe earthquake

Nick Leeson was sentenced to six and a half years in prison in Singapore.


1. No Segregation of duties

• Nick Leeson– Floor manager & back office settlement operation• Internal auditor of Barings Bank, James Baker• Recommended that the General Manager should not responsible for

the back office• recommendations were never been implemented.• At Singapore - not taken any significant steps

Why Barings Bank collapsed?

1. Norris, Chief Executive Office of Barings Investment Bank (BIB)

2. Broadhurst, Group Finance Director of Barings Investment Bank (BIB)

3. Hopkins, Director of Group Treasury and Risk of Barings Investment Bank (BIB)

4. Barnett, Chief Operating Officer of Barings Investment Bank (BIB)

5. Ron Baker, Head of Financial Product Group (FPG)

Copies of internal audit report were distributed to:

No segregation of duties

Create operational risk and fraudulent risk

Recommended solution :

Top management and internal

auditors should ensure proper segregation of

duties in an organization

through frequently review of internal control

process

2. Unauthorized trading activities

Unauthorized trading

activities happened

Managing cheque

Sign off on trading

reconciliations

Signing authorityResponsible for

inspection in bank

reconciliations

Cover for his

shortfalls

Prevent the

London office from

receiving the

standard daily reports

on trading,

price and

status

The creation of “88888” account

Leeson's Positions as at End February 1995.

Number of contracts1

nominal value in US$ amounts Actual position in terms of open interest of relevant contract2

Reported3 Actual4

Futures

Nikkei 225

30112$2809 million

long 61039$7000 million

49% of March 1995 contract and 24% of June 1995 contract.

JGB15940$8980 million

short 28034$19650 million

85% of March 1995 contract and 88% of June 1995 contract.

Euroyen601$26.5 million

short 6845$350 million

5% of June 1995 contract, 1% of September 1995 contract and 1% of December 1995 contract.

Options

Nikkei 225

Nil

37925 calls$3580 million32967 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.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

By just one

Member who is both

buyer and seller

Executed on the floor of

an exchang

e

Cross Trad

e

SIMEX rules

Member must declare the prices for three times

Must be executed at market price

Leeson entered into a significant quantity of cross transactions

Account “88888”(Losses)

account “92000” (Baring Securities Japan – Nikkei and JGB Arbitrage)(Profit)

account “98007” (Barings London-JGB Arbitrage)(Profit)

account “98008” (Barings London-Euroyen Arbitrage)(Profit)

No. of contracts in account “88888” 2

Price per SIMEX

Average Price per CONTACT

Value per SIMEXJPY millions

Value per CONTACTJPY millions

Profit/(Loss)to “92000”JPY millions

Buy Sell

20 January 6984 18950 19019 66173 66413 240

23 January 3000 17810 18815 26715 28223 1508

23 January 8082 17810 18147 (71970) (73332) (1362)

25 January 10047 18220 18318 91528 92020 492

26 January 16276 18210 18378 148193 149560 1367

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.

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”.

3. Lack of Understanding on Derivatives

Bank of England

summarized

Senior manageme

nt teamdid not

understand the risks

Straddles strategy

Downside risk

(potential loss if price

decline)

Lack of understanding on derivative

Cannot provide proper guidance and recommendation in activities done by Nick Leeson



Senior executives should be sent to training or attend

courses to enhance their

knowledge about derivative

1. Anybody who was supposed to have some control over his activities was going elsewhere.

2. The people who were looking after the traders were based in London.

3. The people in charge of the compliance function were in London.

4. The risk management areas were in Tokyo

5. He was both the senior trader and settlements person in Singapore

Nick Leesson personally claimed a severall statement

4. Poor supervision of employees and lack of senior management involvement

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 SIMEX’s system as a customer account).

ii. Initial margin requirement of account “88888” was in excess of US$342 million.

Simon Jones – The Finance Director of Barings Future Singapore (BFS)

The letter on 11 January, 1995

SIMEX’s senior vice president for audit and compliance, Yu Chuan Soo, complained:

The letter on 27 January, 1995

Related to the assurance of BFS’s ability to fund its margin calls

January 1995

• Coopers & Lybrand

• US$83million

• Due from Spear, Leeds & Kellogg (a US investment group)

• Had not been received

Version 1: Related on the 27 January 1995’s letter

• BFS (through Leeson), had traded (or broken) an over-the-counter deal

• Spear, Leeds & Kellogg and BNP, Tokyo

• Involved 200 of 50,000 call options

SHOULD BE WARNED

• The second version is, an ‘operational error’ had occurred

• A payment had been made to a wrong third-party in December 1994

Version 2: Related on the 27 January 1995’s letter

HAD TO STRENGTHEN ITS BACK-OFFICE PROCEDURES

• Based in Tokyo and experienced in the operation of Japanese markets

• Analyzing the risks on Leeson’s intra-day trading activities

• Did not have a clear understanding of his duties in supervision over BFS’s trading activities

• Argued that he was responsible for supervising Leeson’s switching activities

Fernando Gueler – The Head of Financial Product Group (FPG) in Barings Securities Japan (BSJ)

Lack of supervision from top management

Top management failed to implement their fiduciary duties



Top management should have

proper supervision and monitoring over subordinates’

activities

ADDITIONAL PERSPECTIVES

Lack of Corporate Governance Practices

Oversee

B.O

.D

Managem

ent

Govern & Monitor

Consequence

Incompetency of external auditors(Lack of knowledge about derivative)

- Audit firm should send auditors to

attend related courses to enhance

their professional knowledge

- Send specialized skills auditors to audit particular industry

Negligence of External Auditors

Self interest

Cover losses

Gain bonus

Position

Ethical point of views

WHAT IS

DIFFERENT?

Barings Bank

Societe Generale•3rd largest Corporate and Investment

bank in the Eurozone •Futures trader– Jérôme Kerviel •Engage in unauthorized trades

totaling dealt with $73.3 billion (more than the bank's market capitalization of $52.6 billion)

Similarity Differences

Does not collapse with US bailout.

Has well established internal audit and risk management.

Operated in a well establish regulatory system requirement because it happened on at later

date (2007 & 2008).

Undiscovered fraudulent trade method until the discovery of fraud perpetrated by Bernard

Madoff.

Oldest banks in France destroy by single rogue trader

Trader exceeded his authority

Fraudulent trade that exist market capitalization cover losses.

Greedy and desired of making profit for the bank.

Societe Generale

Daiwa Bank•12th largest bank in Japan•Daiwa Bank's bond traders– Toshihide

Iguchi•Toshihide Iguchi had concealed more

than 30 000 trades over 11 years starting in 1984

•Consequently, Daiwa Bank shuts down global operations.

Daiwa Bank


Escaped detection for longer period (11 years).

Do not involve derivates but bond market.

Holding company does not collapse after the

incidents.

A trader had - as Leeson - control of both the front

and back offices.

Happened in the same year (1995).

Lack of internal control and risk management over global

(far west) subsidiaries.

Metallgesellschaft•Largest industrial conglomerates

based in Frankfurt. •Lost over 1.4 billion dollars after

speculating increase in oil price in oil futures market.

•Mismatch between its derivates hedges and long-term oil contracts with customers.

Metallgesellschaft


What regulation has been imposed in response to the collapse of Barings Bank?•Windsor Declaration

▫Hosted by: United Kingdom Securities and

Investments Board and United States Commodity Futures

Trading Commission ▫Attended by:

Regulatory Authorities from 16 countries


▫Purposes: To discuss the key issues resulting

from the failure of Barings Bank and The ways to strengthen supervision The ways to minimize systematic risk

and disruptions.


▫Outcomes: Cooperation between market

authorities Protection of customer positions,

funds and assets Default procedures Regulatory cooperation in

emergencies.

Conclusion

baring bank-rogue trader

Education