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What was Nick Leeson’s strategy to earn trading profits on derivatives?
2. What went wrong that caused his strategy to fail?
3. Why did Nick Leeson establish a bogus error account (88888) when a legitimate account (99002) already existed?
4. Why did Barings and its auditors not discover that the error account was used by Leeson for unauthorized trading?
The Collapse of Barings
(Questions are on page 7)
In February of 1995, one man single-handedly
bankrupted the bank that financed the
derivatives contracts on the Singapore
Mercantile Exchange and Japan’s Osaka
Exchange. A scandal ensued when Leeson left
a $1.4 billion hole in Barings’ balance sheet
due to his unauthorized derivatives
speculation, causing the 233-year-old bank’s
Nick Leeson grew up in London’s Watford
suburb, and worked for Morgan Stanley after
graduating university. Shortly after, Leeson
joined Barings and was transferred to Jakarta,
Indonesia to sort through back-office mess
involving ?100 million of share certificates.
Nick Leeson enhanced his reputation within
Barings when he successfully rectified the
situation in 10 months (Risk Glossary).
In 1992, after his initial success, Nick Leeson
was transferred to Barings Securities in
Singapore and was promoted to general
manager, with the authority to hire traders and
back office staff. Leeson’s experience with
Mercantile Exchange (SIMEX) alongside his
traders. According to Risk Glossary:
quot;Leeson and his traders had authority to
perform two types of trading:
1. Transacting futures and options orders for
clients or for other firms within the Barings
organization, and
2. Arbitraging price differences between
Nikkei futures traded on the SIMEX and
Japan's Osaka exchange.
Arbitrage is an inherently low risk strategy
and was intended for Leeson and his team to
garner a series of small profits, rather than
spectacular gains. quot;
As a general manager, Nick Leeson oversaw
both trading and back office functions,
eliminating the necessary checks and balances
usually found within trading organizations. In
addition, Barings’ senior management came
from a merchant banking background,
causing them to underestimate the risks
involved with trading, while not providing
any individual who was directly responsible
for monitoring Leeson’s trading activities
(eRisk). Aided by his lack of supervision, the
28-year-old Nick Leeson promptly started
unauthorized speculation in futures on Nikkei
225 stock index and Japanese government
bonds (Risk Glossary). These trades were
outright trades, or directional bets on a
market. This highly leveraged strategy can
Nick Leeson opened a secret trading account
numbered 88888 to facilitate his furtive
trading. Risk Glossary says of Leeson:
Downloaded on 06262007 from
stock-market-crash/barings. htm.
He lost money from the beginning. Increasing
his bets only made him lose more money. By
the end of 1992, the 88888 account was under
water by about GBP 2MM. A year later, this
had mushroomed to GBP 23MM. By the end
of 1994, Leeson's 88888 account had lost a
total of GBP 208MM. Barings management
remained blithely unaware.
As a trader, Leeson had extremely bad luck.
By mid February 1995, he had accumulated
an enormous position—half the open interest
in the Nikkei future and 85% of the open
interest in the JGB [Japanese Government
Bond] future. The market was aware of this
and probably traded against him. Prior to
1995, however, he just made consistently bad
bets. The fact that he was so unlucky
shouldn't be too much of a surprise. If he
hadn't been so misfortunate, we probably
wouldn't have ever heard of him.
Betting on the recovery of the Japanese stock
market, Nick Leeson suffered monumental
losses as the market continued its descent. In
January 1995, a powerful earthquake shook
Japan, dropping the Nikkei 1000 points while
pulling Barings even further into the red. As
an inexperienced trader, Leeson frantically
purchased even more Nikkei futures contracts
in hopes to gain back the money already lost.
The most successful traders, however, are
quick to admit their mistakes and cut losses.
Surprisingly, Nick Leeson effectively
managed to avert suspicion from senior
management through his sly use of account
number 88888 for hiding losses, while he
posted profits in other trading accounts. In
1994, Leeson fabricated ?28.55 million in
false profits, securing his reputation as a star
trader and gaining bonuses for Barings’
employees (Risk Glossary). Despite the
staggering secret losses, Leeson lived the life
of a high roller, complete with his $9,000 per
month apartment and earning a bonus of
?130,000 on his salary of ?50,000, according
to “How Leeson Broke the Bank.”
The horrific losses accrued by Nick Leeson
were due to his financial gambling, as he
placed his trades based upon his emotions
rather than by taking calculated risks. After
the collapse of Barings, a worldwide outrage
ensued, decrying the use of derivatives. The
truth, however, is that derivatives are only as
dangerous as the hands they are placed in. In
this case, Nick Leeson was reckless and
dishonest. Derivatives can be tremendously
useful if used for hedging and controlling risk
or even careful trading.
After a series of lies, cover ups and falsified
documents, Leeson and his wife fled
Singapore for Kuala Lumpur, Malaysia. By
then, Barings’ senior management had
discovered Nick Leeson’s elaborate scheme.
The total damage suffered by Barings was
?827 million, or $1.4 billion. In February
1995, England’s oldest, most established bank
was unable to meet SIMEX’s margin call, and
was declared bankrupt. Leeson and his wife
were arrested in Frankfurt, Germany on
March 3 rd. 1995. That same day, the Dutch
bank, ING, purchased Barings for a mere ?1
and assumed all of its liabilities (eRisk).
Nick Leeson was placed on trial in Singapore
and was convicted of fraud. He was sentenced
to six and a half years in a Singaporean
prison, where he contracted cancer (Risk
Barings Fiasco: 'Natural born trader' who thrived on risk dodged controls and fell
into black hole
Donovan and Dan Atkinson on how one man broke the bank by
running up a possible pounds 1bn bill
The Guardian (Pre-1997 Fulltext); Manchester; Feb 28, 1995;
IF ANYBODY had the background, the
to Baring. However, Richard Raeburn,
skill and the temperament to gamble
partner with accountants KPMG, warned
Baring Brothers into insolvency, it was
that another catastrophe could happen
Nick Leeson. He had long experience in
quite easily, especially in the corporate
the bank's paperwork department and its
sector. Big companies, seeking to invest
investigation division to allow him to
He was a quot;natural born traderquot; with the
nerve and inclination to go double or quits
quot;Most corporations lack the systems and
quot;In a well-controlled bank it should not
have been possible to build up such an
He had at least one accomplice - Barings'
enormous position. quot;
computer system, proved once before to
be incapable of monitoring properly the
bank's multi-million pound global trading.
Barings' computers were scarcely up to
All these factors clicked into place in
Barings' Singapore office, with the result
the job, and Mr Leeson used his quot;backofficequot; knowledge to conceal the problem.
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