Barings Leeson example

Nick Leeson at Barings Bank in Singapore So famous that he became a movie: ”Rogue Trader” (1999) Bo Sjö VT 2014 Barings Bank • 1992, Nicholas Leeson, clerk, moved from London to Barings Futures Singapore (BFS) • To head the Singapore International Monetary Exchange (SIMEX) • Trade in options and futures on NIKKEI-225, mainly 10 year Jap Gov Bond, 3-mths euroyen Leeson’s Job • In 1992, took SIMEX exam • Became a floor trader in Singapore • And, the General manager and the Head trader for BFS • But, Trading and Back office are normally split in two units to keep separate records • N.L.’s task was to look for arbitrage between Osaka and Singapore Exchanges NIKKEI-225 and Jap Gov futures No risk-taking was allowed But, Nick Leeson • He did speculate, against instructions! • He placed bets on the direction of price movements on the Tokyo Stock Exchange • Did well at first, soon looses mounted… • 1992: - $2m, 1993: -$21m • 1994: -$185m 1995: -$619m, early Jan and then … Wait there is more… • In 1994 he began selling (equity) straddles (short), speculating in a lower stock volatility on NIKKEI-225 • In early January 1995, he was short in 37,000 calls and 33,000 puts • Plus long in 1000 futures Now In January 17 1995 – A Major Earthquake in Kobe • Markets explode in volatility and N.L looses even more and now het bets even harder (he has nothing to lose), so by February 23 he holds: • 61,000 March futures contracts 49% of open interest • + 24% of all June contracts • + 88% of all Jap Gov Bond futures • + Large amounts of euroyen contracts, betting on lower Japanese interest rates Margin Calls All Over • In Feb 1995 Leeson has to spend $740m in Margin calls • Barings in London gets suspicious, they hear rumors about an extremely big speculator on the Asian Markets London Calling • In the last days of February 1995, Baring sends an inspector • Leeson and his wife decide to leave Singapore for Germany • The total loss was almost 2.10 times Baring’s Equity value • Baring was bought and recapitalized by ING, The Netherlands Lessons of Leeson? • Bad management, Leeson was sitting on two chairs Trading and back office • Better regulations ? Maybe • What has changed - not much, mostly details says Leeson Final Words  ”They have learned nothing” according to Nick Leeson  The scandals have changed from derivatives to accounting  The nature of man? Moral Hazard is the problem - not derivatives as such 10 Nick Leeson 1995 • • • • • Institution: Barings Bank Activity: Nikkei Index Futures Loss: $1.4bn Sentence: years Positioned in Singapore, made money at first, but later losses His hidden losses of £827 brought down the bank Yasuo Hamanaka 1996 • • • • • Institution: Sumito Corporation Activity: Copper Loss: $2.6bn Sentence: years Controlled a relatively large part of the market for copper (5%) Tried to manipulate copper prices Hide losses for some time John Rusak 2002 • • • • • Institution: Allied Irish Banks Activity: FX options Loss: $691m Sentence: 7.5 years ”Solid performer”, spent five years cover up his losses Vince Ficarra, Luke Duffy, David Bullen and Gianni Gray 2003 • Institution: National Bank of Australia • Activity: FX Options, Loss: $268m • Sentences: – – – – Ficarra 44 months Luke Duffy: 29 months Bullen 28 months Gray: 16 months • Broke trading limits 800 times, and inflated profits minutes before the end of the year to get bigger bonuses Bullen and Ficarra were sentenced first Chen Jiulin 2005 • • • • Institution: China Aviation Oil Activity: Jet Fuel Futures Loss: $550m Sentence: years + months Matthew Taylor 2007 • • • • Institution: Goldman Sachs Activity: S&P 500 futures Loss: $118m Sentence: ? Pending? Jerome Kerviel 2008 Institution: Société Générale Activity: European stock index futures Loss: $7.2bn Sentence: years of which years are suspended, to be served starting fall 2014? • The first court sentenced him to payback, but this was upheld by a higher court in 2014 • • • • • • • • • Kweku Adoboli 2012 Institution: UBS (UK) Activity: Exchange Traded Funds (ETF) Loss: $2.3bn Sentence: years Used his knowledge about back office routines to cover his losses from 2008 Worked 16 hours a day, slep under his desk Hunted by the back office he went home and sent a mail to his boss confessing his losses He was close to recup some of the losses but sold off one day to early Also, not fully covered here • Boris Picano-Nacci, 2008: €751m Equity derivatives, ongoing investigation? • Orange County, $1.7b, 1994 • Metallgesellschaft, $1.3b, 1993 • Substantial amounts of money but how and why did it get wrong? Gold Prices go up and Gold Mines go under? An example 22 Gold and Derivatives  Gold mining companies Ashanti in Ghana and Cambior in Canada  1999 September gold prices went up, but these firms made big losses and almost got into default!  How could that be? 23 Miners have long positions!  Typically, mining companies hedge at least 30-40% of future sales  Some mining companies used 15-20 years derivative contracts  15-20 years is a long time!  Critique: Many investors might are not prepared to mandate companies that sell vast proportions of ore reserve at low prices 24 What happened in 1999?  In Jan/Feb 1999 gold prices fell  Miners thought that prices would stay low for the rest of the year  They saw losses from their positions, that could be compensated by incomes from selling out-of-the money call options on Gold  Since, they assumed that gold prices would stay low, it seemed safe and would reduce, or off-set expected losses 25 Earnings from derivatives?  In these firms derivatives trading was seen as a source of income  Thus, they mixed speculation and hedging  When they foresaw low prices, they thought that selling options - and cash in on premiums would lead to better earnings  But, they did more than selling the plain ”vanilla options” 26 They did some Exotic Options The Escalating Ounce: The number of ounces that the writer might have to deliver raises with the gold price The Parisian: The price at which the firm can be asked to sell falls with increasing market prices of gold The outcome was catastrophical 27