Story of how he bought down Barings Bank Nick Leeson Story of how he bought down Barings Bank have you ever seen this movie “Rogue Trader”, whose famous name is Gambler in Korea. This movie was grounded by the real event about the Britain’s Oldest Merchandise Bank “Barings” Bankruptcy in 1995. From now on, I gonna tell you about how Nick Leeson brought down Barings Bank. Graduate School of Technology Management ECTFE _ HAEJU LEE

Arbitrage price diff b/w Nikkei futures traded Who’s Nick Leeson ? Leeson grew up in London’s Watford suburb Worked for Morgan Stanley after graduating from Uni. Joined Barings & was transferred to Jakarta, Indonesia to sort through a bank-office mess involving £100m of share certificates _ successfully rectified in 10month In 1992, transferred to Barings Securities in Singapore Nick Leeson grew up in London’s Watford suburb and worked for Morgan Stanley after graduating from university. Shortly after, Leeson joined Barings and was transferred to Jakarta, Indonesia to sort through a bank-office mess involving 100 million pound of share certificates. Nick Leeson enhanced his reputation when he successfully rectified the situation in 10 months In 1992, after his initial success, Nick Leeson was transferred to Barings Securities in Singapore and was promoted to general manager. Leeson and his traders had authority to perform 2 types of trading First, Transaction futures and options orders for clients or for other firms within the Barings organization, and Second, Arbitraging price difference between Nikkei futures traded in the SIMEX and Japan’s Osaka exchange. Arbitrage is a low risk strategy and was intended for Leeson and his team to get a small profits, rather than spectacular gain. “ Transacting Futures and options orders for clients, Arbitrage price diff b/w Nikkei futures traded on the SIMEX and Japan’s Osaka exchange

Original Role of Leeson : arbitrage trading of the Nikkei futures contract b/w SIMEX & the OSE. - developing the ‘switching’ In reality : in 1992 open an account named as ‘88888’, used as speculative trading. From now on, I gonna tell you time series story how he got a 1.4bilion dollar of liability. On July 1, 1992, Barings Futures Singapore (BFS) started trading on the Singapore International Monetary Exchange (SIMEX). Leeson was put in charge of operations for BFS, with responsibilities both for trading and the accounting and settlements activities. One of the primary trading strategies they implemented was arbitraging baskets of stocks in the Japanese cash market against Nikkei futures. Initially, these transactions were executed between the Tokyo Stock Exchange (TSE) and the Osaka Securities Exchange (OSE), which was the main market for Nikkei futures. However, after the OSE had implemented tighter restrictions, trading on SIMEX became easier and cheaper. As a result, BSJ traders asked Leeson to execute Nikkei futures trades on SIMEX . large price differences existed between the two contracts that were very similar in design. his risks are low, because every long position on one exchange is offset by a short position on the other. In addition to arbitrage trading, Leeson developed an even more lucrative activity, namely ‘switching’. As Barings was able to trade in Japan as well as in Singapore, it could select the cheapest market to execute a client’s order. For example, it could tell a client it would buy 1000 Nikkei futures contracts in Osaka, while in reality it made the purchase on SIMEX, where at that moment the price was lower. On July 3, 1992, only two days after Barings was granted membership by SIMEX, Leeson opened Account 88888 On BFS’s system, this account was described as an error account. It is common for traders to set up for the purpose of netting minor trading mistakes. The net position should be closed each day and the net value of gains and losses should be recorded as part of the unit’s daily profit During 1993, the main focus of Leeson’s unauthorized speculative positions in Account 88888 was the generation of profits in the ordinary trading accounts of BSL, and BSJ for their clients. This enabled Leeson to gain a reputation as a star trader on SIMEX and enhanced his intrafirm executive standing. In 1993 : unauthorized speculative position in Account 88888 generating Profit.

Margin calls from SIMEX : Loss from speculative : by the end of 1993 the cumulative losses in Account 88888 were over ¥ 4billion (about U$35.8 million) Margin calls from SIMEX : Manipulating the trading and accounting records. Despite it, funds needed for margin calls steadily increased. Transfer money from BSL to Singapore : profits are small, volume should be large. SIMEX demanded “advance margin call” Set up a large series of short “straddle” : The position in Nikkei options increased significantly In 1994 However, by the end of 1993 the cumulative losses in Account 88888 were over ¥ 4 billion (about US$35.8 million). Leeson’s main problem became the management of the flow of funds to support the margin calls from SIMEX. An important way to arrange the funding was by manipulating the trading and accounting records Despite the manipulations of the books, the funds needed for SIMEX’s margin calls steadily increased. Leeson used a number of methods to convince BSL management of the necessity to transfer large sums of money to Singapore. In addition to the funds transferred from London, Leeson sold options on the Nikkei index through Account 88888 from the start of 1993. From January 1994, the position in Nikkei options increased significantly when Leeson set up a large short straddle positions.

Long position in Nikkei future : total volume through account 88888 was 90,000 contract (about 7.5% of total trading volume) Not meet margin : Highest value reached in 1994. This reversed to loss of U$108m by Feb 1995(accumulated U$1.4 billion) due to Kobe Earthquake In 1995 The largest part of Barings’ losses came from a massive long position in Nikkei futures. Leeson expanded his long position in Nikkei futures. The total monthly trading volume through Account 88888. In January 1995, the total was 90,000 contracts (SR3.14) or about 7.5% of total trading volume. The highest value was reached by the end of December 1994, when the total value of the options was approximately US$178 million. Mainly due to the Kobe Earthquake, this reversed to a loss of approximately US$108 million by the end of February 1995 As an inexperienced trader, Leeson purchased even more Nikkei futures contracts in hopes of winning back the money that he had already lost. Most successful traders, however, are quick to admit their mistakes and cut their losing trades. Eventually, on February 23, 1995, Barings was not able to meet its margin requirements on SIMEX. The total loss accumulated by Leeson was US$1.4 billion. this amount of liability is more than the bank’s entire capital and reserves. So Barings immediately collapsed and was sold to Dutch giant ING for 1 pound. “ U$1.4 billion in liabilities, more than the bank’s entire capital and reserves. Barings immediately collapsed and was sold to Dutch giant ING for 1 pound!! ”

Oversaw both trading & back office functions, eliminating the necessary checks and balances usually found within trading organizations. Barings’ senior management came from a merchant banking background, causing them to underestimate the risks involved with trading, while not providing any individual who was directly responsible for monitoring Leeson’s trading activities (eRisk) ✔ Lack of supervision - outright trades or directional bets on the market. Highly leveraged strategy can provide fantastic gains or utterly devastating losses. : Problem What was the problem of nick’s trading? There are several reasons to explain to you First, As a general manager, Nick Leeson oversaw both trading and back office functions, eliminating the necessary checks and balances usually found within trading organizations. In addition, Barings’ senior management came from a merchant banking background, causing them to underestimate the risks involved with trading, while not providing any individual who was directly responsible for monitoring Leeson’s trading activities (eRisk). Aided by his lack of supervision, the 28-year-old Nick Leeson promptly started unauthorized speculation in Nikkei 225 stock index future. These trades were outright trades or directional bets on the market. This highly leveraged strategy can provide fantastic gains or utterly devastating losses.

Implication The horrific losses accrued by Nick Leeson were due to his financial gambling as he placed his trades based upon his emotions rather than through taking calculated risks. Actively Risk management is required. There is trade-off between risk & expected return, so management is to maximize firm’s profit related to their risk. Except market & credit risk, operational risk is highly important to manage risk. Through Nick Leeson’s lesson of rogue trader, I can derive some implication as follows First, The horrific losses accrued by Nick Leeson were due to his financial gambling as he placed his trades based upon his emotions rather than through taking calculated risks. Seconds, Actively Risk management is required. There is trade-off between risk & expected return, so management is to maximize firm’s profit related to their risk Finally, Except market & credit risk, operational risk is highly important to manage the financial risk.