Baring Bank-Rogue Trader


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Baring Bank-Rogue Trader

  1. 1. 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)
  2. 2. Privately negotiated Fulfill the need of both side Largely unregulated market
  3. 3. Standardized contracts Acts as an intermediary Provides information of the trading Example: Chicago Board of Trade, Chicago Mercantile Exchange, Korea Exchange
  4. 4. To speculate and make profit due to the changes of the value of the underlying assets. To hedge the underlying asset as whole or part of it. To exposure to underlying asset which it is not possible to trade in the underlying asset market.
  5. 5. 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
  6. 6. 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
  7. 7. 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
  8. 8. In 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.
  9. 9. Derivative trading strategy Inter- exchange arbitrate strategy “Straddle” strategy
  10. 10. Buy and sell Nikkei 225 futures contracts simultaneously Gain the arbitrate profit Inter- exchange arbitrate strategy
  11. 11. In 1992, suffering first loss of $20,000 Create error account –account “88888” In 17 Jan 1995, Kobe earthquake in Japan In 20 January 1995, Nick Leeson decided to double up the long position to 55,206 March 1995 and 5,640 June 1995 contracts
  12. 12. Margin calls about $835m was required by SIMEX. Barings Bank was collapsed in 26 February 1995 ING, a Dutch bank, purchased Barings Bank in 1995 for the nominal sum of £1 Nick Leeson was sentenced to six and a half years in prison in Singapore.
  13. 13. 1. No Segregation of duties • Nick Leeson– Floor manager & back office settlement operation • Internal auditor of Barings Bank, James Baker • Recommended that the General Manager should not responsible for the back office • recommendations were never been implemented. • At Singapore - not taken any significant steps
  14. 14. 1. Norris, Chief Executive Office of Barings Investment Bank (BIB) 2. Broadhurst, Group Finance Director of Barings Investment Bank (BIB) 3. Hopkins, Director of Group Treasury and Risk of Barings Investment Bank (BIB) 4. Barnett, Chief Operating Officer of Barings Investment Bank (BIB) 5. Ron Baker, Head of Financial Product Group (FPG)
  15. 15. No segregation of duties Deficiencies of internal control in Barings Create operational risk and fraudulent risk Recommended solution : Top management and internal auditors should ensure proper segregation of duties in an organization through frequently review of internal control process
  16. 16. 2. Unauthorized trading activities Unauthorized trading activities happened Managing cheque Sign off on trading reconciliations Signing authority Responsible for inspection in bank reconciliations
  17. 17. Cover for his shortfalls Prevent the London office from receiving the standard daily reports on trading, price and status The creation of “88888” account
  18. 18. Leeson's Positions as at End February 1995. Number of contracts1 nominal value in US$ 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. JGB 15940 $8980 million short 28034 $19650 million 85% of March 1995 contract and 88% of June 1995 contract. Euroyen 601 $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 million 32967 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
  19. 19. By just one Member who is both buyer and seller Executed on the floor of an exchange Cross Trade SIMEX rules Member must declare the prices for three times Must be executed at market price
  20. 20. 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)
  21. 21. No. of contracts in account “88888” 2 Price per SIMEX Average Price per CONTACT Value per SIMEX JPY millions Value per CONTACT JPY 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”.
  22. 22. 3. Lack of Understanding on Derivatives Bank of England summarized Senior management team did not understand the risks Straddles strategy Downside risk (potential loss if price decline)
  23. 23. Lack of understanding on derivative Cannot provide proper guidance and recommendation in activities done by Nick Leeson Create operational risk and fraudulent risk Recommended solution : Senior executives should be sent to training or attend courses to enhance their knowledge about derivative
  24. 24. 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 4. Poor supervision of employees and lack of senior management involvement
  25. 25. 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. SIMEX’s senior vice president for audit and compliance, Yu Chuan Soo, complained:
  26. 26. January 1995 •Coopers & Lybrand •US$83million •Due from Spear, Leeds & Kellogg (a US investment group) •Had not been received
  27. 27. •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
  28. 28. •The second version is, an ‘operational error’ had occurred • A payment had been made to a wrong third-party in December 1994
  29. 29. • 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
  30. 30. Lack of supervision from top management Top management failed to implement their fiduciary duties Create operational risk and fraudulent risk Recommended solution : Top management should have proper supervision and monitoring over subordinates’ activities
  31. 31. Oversee B.O.D Management Govern & Monitor Consequence
  32. 32. 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
  33. 33. Self interest Cover losses Gain bonus Position Ethical point of views
  34. 34. Barings Bank Societe Generale Daiwa Bank Metallgese llschaft
  35. 35. • 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)
  36. 36. 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.
  37. 37. • 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.
  38. 38. Similarity Differences 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.
  39. 39. • 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.
  40. 40. Similarity Differences
  41. 41. • Windsor Declaration ▫ Hosted by:  United Kingdom Securities and Investments Board and  United States Commodity Futures Trading Commission ▫ Attended by:  Regulatory Authorities from 16 countries
  42. 42. • Windsor Declaration ▫ 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.
  43. 43. • Windsor Declaration ▫ Outcomes:  Cooperation between market authorities  Protection of customer positions, funds and assets  Default procedures  Regulatory cooperation in emergencies.