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Group Members:KOK KEAN TEONGMOH JIA WEI NEO CHING HUP ONG KAH HOEY TEO SILK KEONG
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Group Members:KOK KEAN TEONG
CEA070059MOH JIA WEI CEA070084NEO CHING HUP
CEA070109ONG KAH HOEY
CEA070157TEO SILK KEONG
CEA070197
Nicholas Leeson and Barings Bank
CAEA 3231 Integrated Case StudyFaculty of Business and Accountancy
What is derivative trading?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)
Privately negotiated
Fulfill the need of both side
Largely unregulated market
Over-The-Counter derivative market (OTC)
Exchange-Traded derivative market (ETD)
Standardized contracts
Acts as an intermediary
Provides information of the trading
Example: Chicago Board of Trade, Chicago Mercantile Exchange, Korea Exchange
Types of Common Derivative Contracts
Purposes of Investing In Derivative MarketTo speculate and make profit due to the changes of the value of the underlying assets.
To exposure to underlying asset which it is not possible to trade in the underlying asset market.
What is the role of investment bank in derivative trading
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
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
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
Brief Story- Barings BankIn 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.
Derivative trading strategy
Inter-exchange arbitrate strategy
“Straddle” strategy
Brief Story- Barings Bank
What was the strategy being implemented by Nick Leeson as required by Baring Bank management ?
Buy and sell Nikkei
225 futures
contracts simultane
ously
Gain the
arbitrate
profit
Inter-exchange arbitrate strategy
What was the strategy being implemented by Nick Leeson to gain more profit ?
“Straddle” strategy
In 1992, suffering first loss of $20,000
Create error account –account “88888”
In 20 January 1995, Nick Leeson decided to double up the long position to 55,206 March 1995 and 5,640 June 1995 contracts
Brief Story- Barings Bank
Is the Nikkei 225 Index is a stable financial instrument?
Performance of Nikkei 225 after Kobe earthquake
Nick Leeson was sentenced to six and a half years in prison in Singapore.
Brief Story- Barings Bank
1. No Segregation of duties
• Nick Leeson– Floor manager & back office settlement operation• Internal auditor of Barings Bank, James Baker• Recommended that the General Manager should not responsible for
the back office• recommendations were never been implemented.• At Singapore - not taken any significant steps
Why Barings Bank collapsed?
1. Norris, Chief Executive Office of Barings Investment Bank (BIB)
2. Broadhurst, Group Finance Director of Barings Investment Bank (BIB)
3. Hopkins, Director of Group Treasury and Risk of Barings Investment Bank (BIB)
4. Barnett, Chief Operating Officer of Barings Investment Bank (BIB)
5. Ron Baker, Head of Financial Product Group (FPG)
Copies of internal audit report were distributed to:
No segregation of duties
Create operational risk and fraudulent risk
Recommended solution :
Top management and internal
auditors should ensure proper segregation of
duties in an organization
through frequently review of internal control
process
2. Unauthorized trading activities
Unauthorized trading
activities happened
Managing cheque
Sign off on trading
reconciliations
Signing authorityResponsible for
inspection in bank
reconciliations
Cover for his
shortfalls
Prevent the
London office from
receiving the
standard daily reports
on trading,
price and
status
The creation of “88888” account
Leeson's Positions as at End February 1995.
Number of contracts1
nominal value in US$ 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.
JGB15940$8980 million
short 28034$19650 million
85% of March 1995 contract and 88% of June 1995 contract.
Euroyen601$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 million32967 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
By just one
Member who is both
buyer and seller
Executed on the floor of
an exchang
e
Cross Trad
e
SIMEX rules
Member must declare the prices for three times
Must be executed at market price
Leeson entered into a significant quantity of cross transactions
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)
No. of contracts in account “88888” 2
Price per SIMEX
Average Price per CONTACT
Value per SIMEXJPY millions
Value per CONTACTJPY 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”.
3. Lack of Understanding on Derivatives
Bank of England
summarized
Senior manageme
nt teamdid not
understand the risks
Straddles strategy
Downside risk
(potential loss if price
decline)
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
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
Nick Leesson personally claimed a severall statement
4. Poor supervision of employees and lack of senior management involvement
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.
Simon Jones – The Finance Director of Barings Future Singapore (BFS)
The letter on 11 January, 1995
SIMEX’s senior vice president for audit and compliance, Yu Chuan Soo, complained:
The letter on 27 January, 1995
Related to the assurance of BFS’s ability to fund its margin calls
January 1995
• Coopers & Lybrand
• US$83million
• Due from Spear, Leeds & Kellogg (a US investment group)
• Had not been received
Version 1: Related on the 27 January 1995’s letter
• 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
SHOULD BE WARNED
• The second version is, an ‘operational error’ had occurred
• A payment had been made to a wrong third-party in December 1994
Version 2: Related on the 27 January 1995’s letter
HAD TO STRENGTHEN ITS BACK-OFFICE PROCEDURES
• 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
Fernando Gueler – The Head of Financial Product Group (FPG) in Barings Securities Japan (BSJ)
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
ADDITIONAL PERSPECTIVES
Lack of Corporate Governance Practices
Oversee
B.O
.D
Managem
ent
Govern & Monitor
Consequence
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
Negligence of External Auditors
Self interest
Cover losses
Gain bonus
Position
Ethical point of views
WHAT IS
DIFFERENT?
Barings Bank
Societe Generale•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)
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.
Societe Generale
Daiwa Bank•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.
Daiwa Bank
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.
Metallgesellschaft•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.
Metallgesellschaft
Similarity Differences
What regulation has been imposed in response to the collapse of Barings Bank?•Windsor Declaration
▫Hosted by: United Kingdom Securities and
Investments Board and United States Commodity Futures
Trading Commission ▫Attended by:
Regulatory Authorities from 16 countries
What regulation has been imposed in response to the collapse of Barings Bank?•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.
What regulation has been imposed in response to the collapse of Barings Bank?•Windsor Declaration
▫Outcomes: Cooperation between market
authorities Protection of customer positions,
funds and assets Default procedures Regulatory cooperation in
emergencies.
Conclusion
Recommended