Financial risk management

Case study: The collapse of Barings Bank What can we learn from this derivatives mishap It was a startling discovery. The staff at Baring Futures Singapore pried open a drawer always kept locked by Nicholas Leeson in February. There was a stack of paper, recalls visiting official Tony Railton, senior clerk for futures and options settlements at Barings group headquarters in London. There were holes in some. London manager Brenda Granger says she saw what looked like a fraudulent document. And Barings settlement director Tony Gamby remembers finding some cut-and-paste material and a letter with a scissor-cut around the signature. These were some of the clues that the three Barings employees provided Bank of England investigators. The results of that probe were finally released last month. The report mainly blames Leeson, 28, for Feb 27 collapse of 233-year-old Barings, Britains oldest merchant bank. Because of limited access to Barings documents in Singapore, the investigators say, they could not shed light on the most disturbing questions. Among them: Was the roque trader part of a conspiracy? Detailed answer may come soon from Singapore. The Bank of England report looks like it intended to put most of the responsibility on Leeson, says one analyst in Lion City. The British may not like it when the Singapore report comes out. Adds a local banker: Some other people could be charged for breaching fiduciary trust. Prepared by two Price Waterhouse executives, Nicky Tan and Michael Lim, the Singapore report is expected to be more thorough. It may spread blame more evenly among Leeson, Barings officials and British regulators. The Singaporeans, who enjoyed the full cooperation of new Barings owner ING Bank of the Netherlands, spoke at length with Barings executives in London, Singapore and Tokyo. Like British probers, they did not interview Leeson, who is being held in German jail. But they sat down with James Bax, Singapore-based regional manager for Baring Investment Bank (BIB), who had warned Barings in London about letting Leeson handle both trading and settlement. The Bank of England was not able to talk to Bax directly, but received comments from him on the reports proposed conclusions. The British probers came down hard on Leeson, who is fighting extradition to Singapore. (He wants to be tried in London.) The Bank of England says the trader appears to have fabricated documents purporting to show that New York securities trader Spear, Leeds, Kellogg (SLK) owed Barings 7.778 billion yen ($86 million). The phoney files were all part of Leesons efforts to hide losses of $1.3 billion incurred over a two-year period from unauthorized futures and options trading on the Singapore International Monetary Exchange and the Osaka Securities Exchange. Leeson had been missing for days when Barings staff forced his drawer open. He had abruptly left a Feb. 23 meeting with Railton to discuss that 7.778 billion yen receivable and never returned. The Bank of England has established that Leeson used a special account, bearing the number 88888, to conceal his losses. The account was set up soon after he arrived in Singapore in 1992. While the report does not specify who opened it, the investigators say Leeson was managing it. The broker later arranged for 88888 to be kept out of most reports sent to London. Because of the subterfuge, Leeson managed to appear a winner, a-star, as an ex-colleague put it, seemingly responsible for huge profits. Barings rewarded him handsomely. Named general manager of BFS in 1993, he got a $195,000 bonus for that year. For his 1994 performance, Leeson was on track to receive an extra $689,000.00 In reality, since about October 1993, Lesson had been accumulating far greater amounts in losses - $332 million by the end of 1994, ballooning to $1.3 billion by the time Barings collapsed. About 75% of the red ink was the result of trades between Jan. 1 and Feb. 27, when the venerable British bank finally fell. Betting that the Nikkei stock index would rise, Lesson bought heavily into Nikkei futures, holding on to them even after an earthquake hit Kobe in January. When he disappeared, he had more than 70,000 futures contracts open. The Bank of England criticized the lack of management controls within BFS. A 1994 internal audit pinpointed potential accountability problems, but it was ignored. Instead, Barings officials complied with Leeson's requests for money - about $1 billion for just the first two months of 1995 - almost without hesitation. "We just accepted his [Leeson's] word that the figures required ran into millions," Anthony Hawes, then BIB group treasurer, told the Bank of England. "The weakness was that the money ostensibly sent down for the client was not being tied down to a particular client." The report provides no real explanation of why account 88888 escaped the notice of Barings monitors for almost three years. The Bank of England investigators also gloss over the reasons why the Bank of England did not know of the fund transfers from Barings to BFS. That oversight apparently cost the job of Christopher Thompson, the Bank of England official overseeing merchant banks, who resigned a week before the report was issued. Bank Governor Eddie George has said no other official would step down. Because they are not part of the cozy British establishment, the Singapore investigators are expected to be far more hard-hitting. They also had access to seized BFS documents in Singapore, a privilege the republic had initially given the Bank of England probers. But after Tan and Lim met difficulties gathering evidence in London, Singapore said the British investigators must get permission from the courts. A judge denied their request. A draft of the Singapore report suggested that Barings executives may have known about Leeson's unauthorized trading for some time. The Singaporeans sent some preliminary findings to, among others, former BIB chief Peter Norris. in June, he submitted a 19-page answer protesting the allegation that he had tried to conceal information about the 7.778 billion yen that SLK supposedly owed BFS. The draft Singapore report charged that after meeting with Leeson on Feb. 16, Norris "thwarted efforts, days before the collapse, to bring the [trading] positions down as a result of his conversation with Mr. Leeson." Norris calls the accusation "baseless, inconceivable and denied." The Bank of England report makes no suggestion of a cover-up on the part of any Barings executive. Tan and Lim have submitted their final report to the government, which is expected to release it by September. What about the man who brought Barings to its knees? Leeson was arrested in Frankfurt in March after flying in from Malaysia, where he and his wife Lisa had been holed up since they fled Singapore. While he waits for Germany to decide whether to send him to Singapore, he is selling his story to various publications .. .for a reported total of $4.5 million. Leeson has not gotten round to naming names yet. But he has promised to do so - to the British Serious Fraud Office. The rogue trader says he will help British authorities win convictions, presumably of others in Barings, if they would ask Germany to extradite him to Britain. But London is said to prefer that he face the music in Singapore. The Singaporeans have charged Leeson with 12 counts of cheating and forgery, which could land him in jail for up to 14 years. Last week Gun Records released in Europe a compact disc by a rock group called the Bollock Brothers. Leeson reportedly contributed a verse from a ballad by telephone connection from jail to a Hamburg studio. The not-so-subtle song: "My Way." The world awaits the would-be minstrel's real recital.

a. Who is responsible for the failure at Barings Bank? Why? (3 marks)

b. Should the Barings Board of Directors be held accountable for the losses? Briefly evaluate the performance of Barings board of directors. (4 marks)

c. Was the existence of the 88888 Account one of the fundamental problems at Barings Bank? Why? (3 marks)

d. If you are the Financial Risk Manager of Barings Futures Singapore (BFS), what are the potential risk mitigation you can take to curb the situation? (5 marks)