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Barings Bank and Nick Leeson

Leeson's Origin. Sorts out mess in Indonesian back officeHead of derivatives trading at Singapore office (Jan, 1992)Concentrated on Nikkei 225 index Arbitrage between Osaka and Singapore (SIMEX). 88888 Account. Trading discrepanciesShort term : settle immediatelyLeeson changes software so that

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Barings Bank and Nick Leeson

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    1. Barings Bank and Nick Leeson Fin285a: Lecture 6.1 Fall 2009 Readings: Marthinsen, chapter 7 Jorion 177-179

    2. Leeson’s Origin Sorts out mess in Indonesian back office Head of derivatives trading at Singapore office (Jan, 1992) Concentrated on Nikkei 225 index Arbitrage between Osaka and Singapore (SIMEX)

    3. 88888 Account Trading discrepancies Short term : settle immediately Leeson changes software so that trades not reported He’s running trading and backoffice Initially Barings Singapore not supposed to trading for its own account

    4. Leeson’s Job As market increases, role of Barings increases Trading on own account Supposedly: Arbitraging between the two markets Leeson continues to use 88888 account: Trading beyond limits Place to hide losses Hide the speculative nature of his positions

    5. Doubling Strategy Bet on Japanese stocks rising Every time index falls: Leeson increases his long positions As stocks continue to fall, Leeson’s losses magnify

    6. Margin Calls Futures markets: marking to market Generate large losses Leeson lies about these Customer accounts Normal part of futures trading Should be generally neutral if he is long in one market and short in another Failure to flag this in London was a big problem

    7. Nikkei Continues to Fall July 94-Feb 95: Nikkei falls, and Leeson continues losing money Fraud increases: Fictitious trades False records Selling option straddles Payout: Win if no change in price Lose if the price increases or decreases Raise cash now, exposed to potential huge losses in the future

    8. Straddle plus Long Future Gain on rise is reduced Magnifies losses on price fall

    9. Final Drop Kobe earthquake, Jan 17 1995 Nikkei falls below 19,000 Leeson tries to single handedly push it back By Feb 1995, Losses = 830 million pounds Barings goes bankrupt Might have been ok, if could have held to Dec 1995 Also, what if positions were unwound “quietly”?

    10. Lessons from Barings Role of traders Customer trades Arbitrage Position trades Role of the back office Oversight on trader behavior Needs to be independent of traders

    11. Lessons from Barings Role of main office Needs to understand and better scrutinize anomalous cash flows Better understand the derivatives business

    12. Risk Management Message Operational risk Fraud Inadequate controls Would VaR have helped? Didn’t really need this technology to reveal Leeson’s risk exposure

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