Fall of Barings

8/4/2019 Fall of Barings

1/4

BaringBrothers&Co.Ltd

Copyright The Professional Risk Managers International Association

1

Summary

InFebruary1995,BaringBrothers &Co.Ltd(Barings)London,collapsedafterlossesof827million

following unauthorised trading in derivatives byNick Leeson in its Singapore subsidiary (Barings

Futures(Singapore)Pte.Ltd,thatcompletelywipedoutthebankscapitalof200million,leavingit

unabletomeetitsobligations.

Thedisaster couldhavebeengreatlymitigated, ifnotentirelyavoided,hadearlier internal audit

reportsdrawingattentiontopotentialriskshadbeengiventheimportancetheydeservedandacted

upon immediately.Forexample,Leeson,thetrader,wasresponsibleformanagingthebackoffice;

suspense accounts were not being properly reconciled; because of internal officejealousies in

Londonnobodywasaskingtoseeevidenceofthecustomersforwhompositionswerepurportedly

takenandonwhichmarginhadtobepaid,etc.

In addition, the small Singapore office was producing profits out of all proportion to its size,

something that should have raised questions in London. The Barings collapse must surely be

consideredasa classicexampleof theperilsofnotactingupon,or simply ignoring, criticalaudit

reports.

HowdidBaringscollapsesoquickly?

InmidFebruary1995aseniorsettlementsclerkwassecondedfromLondontoSingaporetocovera

local colleaguesmaternity leave and quickly identified somemajor problems, not least ofwhich

appearedtobeaUS$190millionblackholeintheaccounts.On23rd

Februarytherewasameeting

between Leeson and the senior settlements clerk to sort out the problem, but after some 30

minutesLeesonmadeexcusesandleftthemeetingnevertoreturn.

Subsequentinvestigationsrevealedthatbytheendof1992Leesonhadbuiltuphiddencumulative

lossesof2million,afigurethatremainedlargelyunchangeduntiltheendofOctober1993.During

NovemberandDecember1993,lossesgrewsharplyto23million.

In1994thecumulative losswas208million,slightlymorethanthereportedBaringsBankGroup

profitof205million,andmorethandoublethe102millioninbonuseswhichBaringshadpaidout

thatyear.

Remarkably in1994, Leesonwas recorded as havingproduced forBarings some28.5million in

revenue,equivalentto77%ofthetotalnetprofitoftheBaringsBankGroup.

FromJanuary1994onwardsLeesonusedoptionsontheNikkei225index,themainJapaneseshare

price indicator, togoshortvolatility in the Japaneseequitymarket, i.e.hewasbetting that the

marketswouldtradewithinanarrowerrangethanwasgenerallyexpected.

TheKobeearthquakeof January17th1995ushered in aperiodofmarket turbulenceandLeeson

started

to

by

Nikkei

futures.

By

6

th

February,

he

had

more

or

less

recouped

the

additional

losses

incurred immediatelyafter theearthquakeandhadacumulative lossof253million,only22%

higher than that of the 208million at the beginningof the year.Unfortunately, from this date

onwardstherewasapersistentdownwardtrend in themarketandas themarketbegan toslide,

Leesongreatlyincreasedhisexposure,resultinginthe827millionlossofjustthreeweekslater.

Previously, in January 1995 The Singapore Futures Exchange (SIMEX) hadwritten two letters to

BaringsSingaporeoffice.The first,on11th January, referred to theaccount '88888',queried the

accuracy of information provided byBarings Singapore relating to certainmargin requirements,


2/4



2

complainedofthelackofinformationandexplanationsintheabsenceofLeeson,andreferredtoa

possibleviolationofSIMEXrulesbyBarings financing themarginrequirementsofclient.Leesons

managerleftittoLeesontodraftaresponse.Theletterof27thJanuarysoughtanassuranceofBFS's

abilitytofunditsmargincalls.

Itisthereforeeasytoconcludethat:

thelosseswereincurredbyreasonofunauthorisedandconcealedtradingactivities; the truepositionwasnotnoticedearlierby reasonofa serious failureof controls and

managerialconfusionwithinBarings;andthat

the truepositionhadnotbeendetectedprior to the collapseby theexternalauditors,supervisors,orregulatorsofBarings.

ButoneofthemanyintriguingaspectsofthiscaseiswheredidLeesongetthemargincashfrom,

whichfuturesandoptionsexchangesrequiretraderstodeposittoensuretheyhaveenoughfundsto

cover any open positions with the exchange? The SIMEX has particularly stringent margin

requirementsandLeesonclearlyneededfundsfromsomewhereintheBaringsGrouptosupporthis

everincreasingpositionsontheexchange.

Barings Singapore appears to have told London that the fundswere required to support client

business,andnotforproprietarytradingactivities.Accountants inLondonwerereportedasbeing

suspicious,aswelltheymighthavebeen,asfundingfromSingaporefromtherestoftheGrouphad

explodedfromaround200millionon19th

Januarytoaround750millionon23rd

February,justone

monthlater.

Butdespitethisincreaseof550million,whichmusthavetaxedBaringsoverallcorporateliquidity

resourcestothelimit,nobodyappearedtohavequestionedthetransfer,nodoubtbearinginmind

Leesonsreputationinthebankasbeingalmostamiracleworkerandturboarbitrageur.

Timelineofevents

1992July

SuspenseAccount88888openedupshortlyafterLeesonwaspostedtoSingapore,toaccommodate

hisearlylossesof2million

1993

BaringsreportedGroupprofitsof100million,whileLeesonhadcumulativelossesof23milliion

1994

BaringsreportedGroupprofitsof205million,whileLeesonhadcumulativelossesof208million.

Meanwhile, Barings external audits, Coopers& Lybrand expressed the view that the controls in

placeinSingaporeweresatisfactory.

1995

By theendof January therewere factorswhich shouldhavealerted Londonmanagement to the

existence of potential problems within Barings Singapore. There were rumours in the market

concerningBarings'verylargepositionontheOsakaStockExchangeandSIMEX,andpossibleclient

problems.


3/4



3

Indeed,querieswereraisedatahigh level fromreputablesources,andeven includedaqueryon

27thJanuary1995fromtheBankforInternationalSettlementsinBasle.Theserumourspersistedin

February.

Alsoon27th

January,theheadofBaringssettlementsandbackofficereceivedaletterfromSIMEX

warningofa74millionshortfall

Between 19th January and 23rd February, the Barings Group apparently unquestioningly had

transferred550milliontoSingaporetosupportLeesonsunauthorisedSIMEXpositions.

InmidFebruarythesecondedseniorsettlementsclerkfromLondondiscovereda190millionblack

holeintheSingaporeaccounts.

On23rdFebruary,inSingapore,Leesonisconfrontedwiththeproblemandwalksoutofameeting.

On theMondayafter thecrisisbroke theChairmanofBarings,PeterBarings,said inLondon that

Baringsderivativearbitrageoperationshadbeenveryprofitableandthat intermsof itsfinancial

exposuresitwasinprincipalalowriskbusinessuntilthefraudtookplace.

BytheendofFebruary,Baringshadcollapsed

OperationalRiskLessonstobeleant(somany!!)

1. Theproblemarose,notbecauseofthecomplexnatureoftherisksbeingtakeninanynewfangledinstruments,butfromastraightforwardfailureofoldfashionedinternalcontrols.

ThefactthatLeesonwaspermittedthroughouttoremaininchargeofbothfrontofficeand

backofficewasamostseriousfailing.

2. Management failed to give due priority to their own internal auditors, who generallyperformedwellbutwhosecommentswere ignored.TheBaringsGroupTreasurerhad, in

February1994,identifiedthedualroleofLeeson(workinginthefrontandbackoffices)as

unsatisfactory. Although the internal audits did not unearth the existence of the

unauthorisedactivities,the internalauditreportdidmakespecificrecommendationsasto

theseparationofroles.Theserecommendationswereneverimplemented;andatthelocal

operational level there seems to have taken no significant steps to give effect to the

recommendedsegregationofduties;eventhoughinhismanagementresponsetothereport

the localmanager had stated thatwith immediate effect (1994) Leesonwould cease to

perform certain functions and that he would ensure the adequate supervision of all

settlementandrecordingprocesses.ThesubsequentBankofEnglandreportconsideredthat

this failure toput intoeffecthismanagement response to these recommendations in the

internalauditreportswasreprehensible.

3. Inaddition,Coppers& Lybrand, theexternalauditors,came in for severe criticism in theofficial report, especially over their 1994 conclusion that the internal controls were

satisfactory. This observation is not easy to reconcile with the transparent lack of

segregation of duties as well as other glaring shortcomings within the Singapore

subsidiary. (Asanaside, it transpired thata fax,supposedlyconfirmingavital transaction

butlaterfoundtobeaforgery,wasfoundintheCoopers&LybrandauditfilesinSingapore.

ItcontainedtheheaderFromNickandLisa!!)


4/4



4

4. The unauthorised trading was concealed by a number of devices. These included thesuppressionofaccount'88888'fromBaringsinLondon(whichaccountwasmentionedonly

inthemarginfilesanddidnotattracttheattentionofBaringsinLondon);thesubmissionof

falsifiedreportstoLondon;themisrepresentationoftheprofitabilityofBFS'strading;anda

numberoffalsetradingtransactionsandaccountingentries.TheinternalaccountNo.88888

hadbeenopenedupaslongagoas1992,whichraisesthequestionofwhowasresponsible

forreconcilingsuspenseaccounts,andwhydidneithertheinternalnorexternalauditors

pickuponthisduringtheirregularaudits.

5. Management in the headoffice fell into the trap of hesitating to restrain a trader whoappeared tobegeneratingadisproportionateamountofprofits (25%ofthetotal) from

essentially a lowrisk, supposedly notolow income generating area of the bank. The

banksChairmandidacknowledge that thebankwasawareof the risksbecause...itwas

possibletohedgeitscontractssimultaneously,leavingthebankwithminimumexposureto

marketmovements,butclaimednoknowledgeofhowLeesonoperated!

6. Management inLondonfailedtoensurethatremunerationofoneoftheirstartradersdidnotencourage risk taking (i.e. thebonusportionofhis remunerationwas tooclosely

tied tohisperformance). Leesons salarywas reportedlyonly50,000buthisanticipated

annualbonusfor1994was450,000ninetimehissalary,andanincreasefrom130,000

thepreviousyear!)

7. Management in London placed Leeson under considerable pressure to produce profits(without,itmustbesaid,ofaskingtoomanyquestions)sothattheirownbonusescouldbe

paidinLondon).

8. BaringsinLondonsent550milliontoSingaporeinlittleoveramonthtofundmargincallsbutalthoughtheaccountantsweresuspiciousaboutthetransfers(notwithstandingthe8

hourtimedifferencebetweenLondonandSingapore,butacknowledgingtheexistenceofan

emailsystem)nobodyappearstohaveasked forprecisedetailsofthepositionsandthe

clientswhichgaverisetosuchlargemargincalls.

9. Managementfailedtoensurethatclienttradingandproprietarytradingwereseparatelycontrolled and accounted for and properly monitored, and that there was a proper

segregationofdutiesbetweenthefrontandbackofficesinSingapore.

10.Thereappearstohavebeenconfusionoverthedistinctionbetweenriskcontrolandriskmonitoring.

ExtractedfromtheBankofEnglandReportoftheBoardofBankingSupervisionInquiryinto

the Circumstances of the Collapse of Barings published 18 July 1995; and from Great

FinancialDisastersofourTimebyAlanN.Peachey,ISBN3830511620.

Documents

Fall of Barings