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Nicholas Leeson sinks Barings single-handedly. Outline. How Leeson traded The damage Who’s to blame: The anatomy of a murder Management’s responsibility & red flags Conclusion. Who’s who. Baring Brothers in London: Britain’s oldest merchant bank

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Presentation Transcript
  • How Leeson traded
  • The damage
  • Who’s to blame: The anatomy of a murder
  • Management’s responsibility & red flags
  • Conclusion
who s who
Who’s who

Baring Brothers in London: Britain’s oldest merchant bank

Nicholas Leeson: The general manager of Barings Futures Singapore (BFS) starting in 1993

Leeson started his career as a derivative trader

leeson s trading
Leeson’s Trading

“Arbitrage” futures between SIMEX and OSE

Sell straddles

arbitrage between simex and ose
“Arbitrage” between SIMEX and OSE

Involves going long in one market and short in the other one.

Leeson’s went long in Osaka.

(His position was public knowledge since the OSE publishes weekly data)

Leeson should have gone short in Singapore; he went long instead (unauthorized trades).

selling straddles
Selling straddles

Straddle = Sell one put and one call with same strike and maturity

Benefits the seller if prices don’t change much (i.e., the options expire worthless)

Leeson sold straddles on the Nikkei 225

Note: Leeson did not have the authority to sell options

tough luck
Tough luck

On January 17, 1995, the Kobe earthquake hit Japan, causing the Nikkei to fall below 18,000.

Put options moved deep in-the-money.

it ain t no brain surgery
It ain’t no brain surgery

When you speculate in long futures and prices drop = you lose

When you sell straddles and prices drop = you lose

Keep in mind: Losses from selling call options are potentially unlimited!

bottom line
Bottom line

Barings collapsed because it could not meet its obligations:

(Courtesy of Nicholas Leeson)

  • Over US$7 billion on the Nikkei 225 equity contracts
  • Over US$20 billion on Japanese bonds and Euroyen contracts
how was it possible
How was it possible?

Leeson was very astute, but reckless

Senior management was utterly incompetent

Lack of adequate organizational structure to allow for proper checks & balances and effective monitoring

leeson s part
Leeson’s part

Leeson set up an error account - the infamous account 88888 (not known to senior management in UK).

He then engaged into a significant volume of cross trading between account 88888 and other accounts

Cross trading = matching the positions of two accounts belonging to the same client

Ex: If Barings owed US$500m to Daiwa Bank from one type of transaction but also expected to receive US$300 from Daiwa from another type of transaction, it could net the two amounts through a cross trade.

After executing these cross-trades, Leeson would instruct the settlements staff to break down the total number of contracts into several different trades, and to change the trade prices to cause profits to be credited to account 92000, while charging losses to account 88888 account

What appeared to be an arbitrage was in fact a speculation disguised with the help of account 88888.

faulty organizational structure and delegation of powers
Faulty organizational structure and delegation of powers

Leeson was in charge of the front and back office

From the front office he was conducting trades

From the back office (records office) he confirmed and settled trades undertaken by the front office

Leeson was in charge of his own supervision!

An internal audit in August 1994 concluded that Leeson’s dual responsibility was an excessive concentration of powers

other red flags
Other red flags

BFS was asked by SIMEX to explain some margin inconsistencies related to account 88888

Leeson was put in charge of responding to SIMEX

No one in London knew how Barings acquired a US$83m receivable from Spear, Leeds & Kellogg.

Leeson’s cash requests for the first two months of 1995 amounted to US$1.2 billion

No one asked for justifications

Staff in London could not reconcile funds remitted to BFS to both proprietary in-house and individual client positions.

senior management s part
Senior Management’s part

Mgmt. failed to follow up on the internal audit

Mgmt. had a poor understanding of derivatives

Mgmt. failed to understand the risks of the business

Mgmt. failed to supervise properly

wishful thinking
Wishful thinking

Senior mgmt. believed that Leeson’s positions were hedged because the alternative was inconceivable

Senior mgmt. should have made sure it was hedged

Probably they also believed in market efficiency and natural selection:

They were right, but headed for extinction


An unlikely series of events in the market +

One rogue trader +

Incompetent management =


The demise of one of world’s oldest and most respectable bank