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 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) YearReported (Million)Actual (Million) 1993+£ 8.83-£ £ £ £ £ 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 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?