The sudden collapse of 233-year old Barings plc, the oldest bank in England,
was due in part to the ability with which extremely arcane financial instruments
such as derivatives could be exploited to mask activities which may, although
inadvertently, nevertheless generate a systemic risk for the entire global
financial system. Peter Norris the head of Barings investment banking, stated
- amazingly - that none of Barings' top managers actually understood the
intricacies of derivatives trading:
"The collapse...of the British merchant bank, Barings
Plc., posed a serious threat to the international financial system -- a
threat that was averted only by heroic efforts, including midnight phone
calls and ad hoc cooperation among regulators."
Joseph B. Dial, Commissioner, Commodity
Futures Trading Commission
"The [Bank of England] report reflects badly on the
Bank of England, badly on Mr. Leeson, but worst of all on the senior management
of Barings. It defies the comprehension of an outsider
that a single individual could have wreaked such havoc for almost three
years without detection."
London Daily Telegraph (quoted
in) Nick Leeson_Rogue Trader_1996, at 252.
"We were a motley crowd. Nobody would have thought
that these were some of the fastest brains and most highly-paid people
in the world. They all looked down-at-heel and hungover, as if they'd stumbled
out of some homeless shelter. Dave Mousseau of First Continental wouldn't
have been let into a restaurant with his sad trousers flapping around his
heels and his stained shirt and tie....
The only good thing about hiding losses from these people
[Barings senior management] was that it was so easy. They were always too
busy and too self-important, and were always on the telephone. They had
the attention span of a gnat. They could not make the time to work through
a sheet of numbers and spot that it didn't add up...
As each day went on, and my requests [for millions] continued
to be met, the explanation dawned on me: they wanted to believe that it
was all true. There was a howling discrepancy which would have been obvious
to a child--the money they sent to Singapore was unaccounted for--but they
wanted to believe otherwise because it made them feel richer....
One day I asked for $30 million....
Nobody asked me outright how on earth I had arranged for
the 7.78 billion yen to leave Barings. I knew from my experience in Jakarta
that when it came down to detail, no senior managers actually wanted to
get their hands dirty and investigate the numbers. They always assumed
that they were above that, and let other people get on with it. Luckily
for my fraud, there were too many chiefs who would chat about it at arm's
length but never go further. And they never dared ask me any basic questions,
since they were afraid of looking stupid about not understanding futures
and options.
I was astonished that nobody stopped me. People in London
should have known that I was making up the numbers...My numbers were hopelessly
out of orbit, yet nobody stopped me...."
Nick Leeson [futures trader, Barings BFS]_Rogue Trader_1996,
at 141, 160, 161, 177.
"...one of London's oldest and most prestigious merchant banks,
Barings, was placed in administration in February owing more than 600 million
[pounds] (approximately Cdn $1.3 billion) on open-ended derivatives contracts
entered into through its Singapore operations."
"The collapse...of the British merchant bank, Barings Plc., posed
a serious threat to the international financial system -- a threat that
was averted only by heroic efforts, including midnight phone calls and
ad hoc cooperation among regulators."
Joseph B. Dial, Commissioner, Commodity Futures Trading
Commission
"This time, though, Barings officials in London were alarmed. No
wonder. When the newspapers first got hold of the story, the speculation
was that Leeson had skipped town because of substantial trading losses.
In fact, he had totally wiped out the 233-year-old Baring Investment
Bank, which proudly counted Queen Elizabeth as a client. Leeson left behind
liabilities totaling $1.3 billion, more than the entire capital and reserves
of the British institution. The fiasco - and a similar scam at the New
York branch of Japan's Daiwa Bank in October - shocked the world's financial
markets."
"SINGAPORE -- Former Barings trader Nick Leeson was locked up in
a maximum-security cell Friday after prosecutors formally charged him with
fraud and forgery in the $1.4 billion collapse of Britain's oldest merchant
bank."
"Barings Plc, the 233-year-old British investment bank that helped
finance the Napoleonic wars and the Louisiana purchase, is broke after
one of its Singapore traders lost more than $1 billion.
The bankruptcy, one of the largest in British history, battered the
pound sterling and pushed stocks in more than a dozen countries into a
tailspin as investors scrambled to recover assets....
The Baring bombshell is the latest derivatives explosion to rock the
securities industry as financial regulators around the world pay increased
attention to these risky investment in a $14 trillion market....
Barings' troubles are the result of highly leveraged bet[s] -- worth
more than $7 billion, traders estimate -- using futures and options tied
to the Nikkei 225 stock index."
"'[director of studies at the Council on Foreign Relations]...Many
chicken littles had predicted during the late 1980s and early 1990s that
trading in derivatives--futures, swaps, and options--would trigger the
next global financial crisis. But they overlooked the important role that
derivatives have played in moderating systemic risk...Significantly, the
Bank of England did little to reassure markets during the Barings collapse.'
The truth of the matter is that the Bank of England didn't begin to
understand what had happened at Barings, or what its impact might be. There
was a systemic risk in the Barings collapse, and if the matter had
been left with the banking regulators, a disaster scenario might well have
played out....
Singapore was umbilically linked to Chicago, still. Nobody knew what
went on inside Osaka, which was by far the larger exchange. If those exchanges
failed to open on Monday or Tuesday, the Chicago and London and Paris and
Sao Paulo markets might well have failed to open on Tuesday or Wednesday."
Martin Mayer_The Bankers_1997, at 352-354.
"Nick Leeson's sour half grin has become a symbol of the horrendous
risks involved in the derivatives markets. The risks were made comprehensible.
Scared bank managers then reassured us that the Barings Bank disaster was
the works of a crook and that their systems would see to that it would
not happen again. Rest assured and back to normal.
Do these managers know what business they are in? Did the sacked managers
of Barings Bank know what business the Queen's bank had entered? A lot
evidences that they did not. Derivatives are pure information and the business
logic of the new information markets challenge lots of things that managers
today take for granted.
In less than ten years the professional financial markets have become
the most information-intensive environment in the world. They are extreme
and they are therefore - for better and for worse - good illustrations
of what we can expect in other environments when information in computerized
networks replace physical goods and physical transactions."
"With the approval of the Fed, the Bank of England handled the
Barings matter, which really did present serious systemic risk, as though
it were simply the failure of a medium-sized bank. The banking regulators
both in England and here did not understand that the failure of Barings'
derivatives subsidiary might--and almost did--provoke a failure at the
Singapore commodities exchange clearing house which is joined at the hip
with the Chicago Merc."
"When I first stepped out on to the trading floor, I could smell
and see the money....
Now, out on the trading floor, I could work with instant money - it
was hanging in the air right in front of me, invisible but highly charged,
just waiting to be earthed. As I watched the traders all screaming at each
other in their red jackets, I imagined an electrical thunderstorm....
...the time gap and the leverage in the futures market means that the
futures are far more volatile than the share index itself....
For a few seconds a difference would open up between the Osaka and Singapore
prices and that's when we went into action.
'OK,' I told Fernando. 'Bought 200 at 580.'
'Cheers, Nick, I've sold at 590.'
We had sold in Osaka and bought the same contracts in Singapore for
a L16,000 profit. And the risk? Two and a half seconds before, the market
would have seen us coming like a big red London bus and moved up....
We scurried over to the OUB building and joined the crowd of dealers
at the entrance to SIMEX. They were having their last drags on their cigarettes
before they started really exercising their lungs. We were a motley crowd.
Nobody would have thought that these were some of the fastest brains and
most highly-paid people in the world. They all looked down-at-heel and
hungover, as if they'd stumbled out of some homeless shelter. Dave Mousseau
of First Continental wouldn't have been let into a restaurant with his
sad trousers flapping around his heels and his stained shirt and tie....
The only good thing about hiding losses from these people [Barings senior
management] was that it was so easy. They were always too busy and too
self-important, and were always on the telephone. They had the attention
span of a gnat. They could not make the time to work through a sheet of
numbers and spot that it didn't add up....
As each day went on, and my requests [for millions of British pounds]
continued to be met, the explanation dawned on me: they wanted to believe
that it was all true. There was a howling discrepancy which would have
been obvious to a child--the money they sent to Singapore was unaccounted
for--but they wanted to believe otherwise because it made them feel richer....
One day I asked for $30 million....
Nobody asked me outright how on earth I had arranged for the 7.78 billion
yen to leave Barings. I knew from my experience in Jakarta that when it
came down to detail, no senior managers actually wanted to get their hands
dirty and investigate the numbers. They always assumed that they were above
that, and let other people get on with it. Luckily for my fraud, there
were too many chiefs who would chat about it at arm's length but never
go further. And they never dared ask me any basic questions, since they
were afraid of looking stupid about not understanding futures and options.
I was astonished that nobody stopped me. People in London should have
known that I was making up the numbers...
My numbers were hopelessly out of orbit, yet nobody stopped me....
I was already 10,000 JGB contracts short, so my position was swinging
into profit or loss by a factor of $500,000 for every tick movement in
the index. The index would typically move about 40 ticks in either direction
in a day's trading, so I was looking at $20 million swings....
'Tony, its Nick. I've just had a message that you needed to speak to
me.'
'Its's this SLK [$7.78 billion yen Leeson lost trading and hid] and
BNP thing, ' he spluttered. 'What's bothering me is where you got all that
money to actually, ah, pay SLK. I mean it's the equivalent of $78 million.
It just doesn't add up, you know.'
Of course it doesn't add up! I felt like shouting. A three-year-old
could tell you that! I was in Ireland and I didn't kiss the Blarney Stone
and we just got pissed and I never intended to come back here. It's all
bogus."
Nick Leeson [Futures trader, Barings BFS]_Rogue Trader_1996, at 33,
34, 35, 99, 141, 160-161, 177, 185, 186, 195.
"Yet on December 31, 1994, Leeson's BFS required $350 million of
funding to meet its margins--and by February 24, 1995, the total was more
than $1.1 billion, more than twice the reported capital of the Barings
Group. How could a man who was supposed to be running a matched book--and
was showing an exact balance of contracts bought and contracts sold in
his daily reports to the home office--need so much margin?...
But what keeps recuring in the Singapore report is puzzlement over how
England could conceiveably have shipped all that money to BFS..."
Martin Mayer_The Bankers_1997, at 343, 350.
[Barings] CEO Norris told the Singapore probers that the money continued
to flow because they believed Leeson's activities yielded good returns
while posing little or no risk. 'This explanation is absurd,' the [Singapore]
report says, 'because the suggestion that a low-risk trading strategy can
consistently yield high returns is implausible'...
And at an ALCO meeting on Feb. 8, Norris dismissed the SLK receivable
[7.78 billion yen] as a mere operational error. The Bank of England report
fails to discuss the whole episode, which is a key part of Singapore's
case for a cover-up."
Asiaweek
"Madam Speaker, the House will be rightly concerned about how such
huge unauthorized exposures could be allowed to happen and build up so
quickly without the knowledge of the company, the exchanges or the regulators."
UK Treasury Chancellor's Statement on the Insolvency
of Barings
"In case after case, investigations
of traders who lost hundreds of millions of dollars found their managers
were loathe to examine their trading as long as they were making money....
While Leeson's trading accounted for more then 40 percent of the entire
bank's reported profits, Peter Norris, head of [Barings] investment banking,
said that none of the company's top managers actually understood the intricacies
of derivatives trading."
"The [Bank of England] report reflects badly on the Bank of England,
badly on Mr. Leeson, but worst of all on the senior management of Barings.
It defies the comprehension of an outsider that a single individual could
have wreaked such havoc for almost three years without detection."
London Daily Telegraph (quoted in) Nick
Leeson_Rogue Trader_1996, at 252.
A couple of the people who were in the core places within Barings that
should have been administering a high level of control ...had what I would
describe as almost no understanding of the fundamentals of the business.
Nick Leeson, Interview with David Frost, British Broadcasting Corporation,
Sep't 11, 1995.
"I marveled at how every single Barings person blamed somebody
else - especially me - rather than themselves. It was as if they needn't
have been employed at all."
Nick Leeson_Rogue Trader_1996, at 250.
Most technical analysts - those who trade, not those who sell it to
the public - understand that a winning system must remain a secret system.
This is especially true in the futures and derivatives world which is a
zero-sum game. It does not create wealth - it merely shifts it around amongst
the players. For every winner there is a loser.
The futures and derivatives markets offer the erstwhile speculator the
possibility of turning a few thousand into many millions (positive or negative)
in a very short space of time. Every speculator's Holy Grail is the trading
system that produces consistent profits - fast! So great are the rewards
that almost any effort is justified in its pursuit.
Anyone who had developed a winning system would guard its secret with
their life. To tell anyone how it worked, even ones employers, would be
courting disaster. Just as stockjobbers jealously guarded their own 'book'
on the floor of the stock exchange - knowledge is power. It is quite possible
that Nick Leeson's personal trading system was never completely revealed
to his employers, especially if he was developing it on the fly. More importantly,
it is highly probable that it would have been kept secret from Leeson's
fellow traders in Singapore. This could well explain why Leeson and his
wife were so deeply involved in the back-office. Anyone with access to
his trading records might be able to deduce his system. That person could
walk into a rival firm and write his own ticket on the back of Leeson's
established trading success. Certainly, Barings' senior management would
have wanted to protect such a valuable asset. Regulators and human nature
do not always coincide in their objectives."
BARINGS: A Random Walk to Self-Destruction
"the pure leverage of derivatives makes it imperative that proper
controls are in place. Since only a small amount of money (called a margin)
is needed to establish a position, a firm could find it facing financial
obligations way beyond its means. The leverage and liquidity offered by
major futures contracts - such as the Nikkei 225, the S&P 500 or Eurodollars
- means that these obligations, once in place, mount very quickly; thus
bringing down an institution with lightning speed."
"All current economics textbooks are based on the national economy
as though that were still the keystone of an understanding of how the world
works. Yet the fact is that the world economy is now, in large part, an
interconnected system of electronic signals. When a twenty-eight-year-old
English junior banker can risk over a billion dollars from a branch in
Singapore, lose it in Tokyo, and thus bankrupt a venerable institution
in London, it is clear that the world is changing."
Newt Gingrich_To Renew America_1995, at 64
"Barings led to the Windsor Declaration, relating to international
cooperation in emergencies and protection of customer funds and assets
in the event of cross-border default. It also led to the March 1996 Declaration
on Cooperation and Supervision for sharing large exposure information,
which to date has been signed by 20 regulators world-wide, and its companion
agreement, which to date has been executed by 62 international exchanges
and clearinghouses."
Brooksley Born, Chairman, Commodities and Futures Trading Commission
"Whenever a scandal like the Barings debacle is uncovered there
is a demand that legislators and regulators should ensure that nothing
similar occurs again. All too often such action is merely a case of locking
the stable door after the horse has bolted. Could frauds on a massive scale
be foreseen? Regulators are hardly likely to answer yes because that would
undermine their excuses for their failures."
"The collapse of Britain's Barings Bank; the problems at MetallGesellschaft,
and, in the United States, the Bankers Trust enforcement action are all
still fresh in our minds. These events heightened concern over whether
derivatives are being used properly.
It's clear that regulators and market participants must recognize and
work together to address the potential risks posed by derivatives trading....
Derivatives are like electricity -- dangerous if mishandled, but also
capable of doing enormous good."
Chairman Arthur Levitt, US Securities & Exchange
Commission
"The Chairman of Barings plc, Peter Baring, described the failure
of controls with regard to BFS as 'absolute'. We agree."
International Finance and Commodities Institute (IFCI)
