[stephenkhoo]

Lessons learnt in Barings debacle
The Monetary Authority of Singapore celebrated its 40th anniversary this year with the publication of a book that tells its history through interviews with leaders past and present. The following is an extract, which recounts the drama that unfolded when the British bank Barings was brought down in 1995 by rogue trader Nick Leeson.

Published on Dec 4, 2011
Nick Leeson being arrested. Singapore suffered no impact, but the debacle was a timely reminder of the importance of an effective, proactive regulatory framework. -- ST FILE PHOTO

Nick Leeson being arrested. Singapore suffered no impact, but the debacle was a timely reminder of the importance of an effective, proactive regulatory framework.

The Monetary Authority of Singapore celebrated its 40th anniversary this year with the publication of a book that tells its history through interviews with leaders past and present. The following is an extract, which recounts the drama that unfolded when the British bank Barings was brought down in 1995 by rogue trader Nick Leeson. - ST FILE PHOTO
The 1995 collapse of Britain's oldest merchant bank, Barings, offers an insight into the potential impact of the failure of one of the hundreds of foreign financial institutions that do business daily in Singapore.

The bank's collapse stemmed mainly from the activities of one Nick Leeson, then-general manager of Barings Futures (Singapore), or BFS.

Mr Leeson ran up huge losses on massive futures positions when the market in Japan went against his bets. He covered up the red ink by using a false trading account numbered 88888, concealing trades from the Singapore International Monetary Exchange (Simex).

Thereafter, Mr Leeson engaged, on a rapidly increasing scale, in unauthorised trading in futures and options through this account, betting progressively more to try and win back his earlier losses.

His unauthorised trading activities intensified until eventually the spiralling debts he chalked up caused the 240-year-old bank to collapse under losses totalling a staggering US$1.4 billion.

Simex dealt swiftly and effectively with the problems created by Barings' high-risk trading activity. The open positions in BFS' books were transferred within a week of Mr Leeson failing to meet his margin calls, with minimum disruption to the market. In the end, investigations showed that the fault lay with Barings London.

It was a combination of poor judgment and a failure of internal controls by a bank that should have been aware of what Mr Leeson was doing.

Still, in the wake of the Barings debacle, Simex and the Monetary Authority of Singapore (MAS) began working towards more effective regulation and greater information sharing among regulators and exchanges. The rules of business conduct on Simex were reviewed to enhance the monitoring of risk exposure, while a global panel of experts was formed to advise the exchange on the best practices in the futures industry.

The Barings drama started on Thursday, Feb23, 1995, when the bank's deputy chairman, Mr Andrew Tuckey, received a call in London from Barings' Singapore office reporting that a dealer had run up massive losses on derivatives trades.

Mr Leeson could not be contacted, having fled to Malaysia with his wife that same evening. BFS officials conducted more checks and by Friday they had discovered the fraudulent 88888 account.

The Bank of England became involved and quickly put together a crisis team that was given until Sunday midnight British time - when the Tokyo stock markets would reopen - to persuade British and foreign banks to launch a lifeboat to keep Barings afloat.

Fortunately, news of the impending disaster did not leak out to the public on Friday, so financial markets were not disrupted.

MAS was immediately alerted to the losses. The weekend saw a flurry of meetings between Simex's executive committee and MAS to formulate the emergency actions that needed to be taken when the market reopened on Monday.

Meanwhile, Simex clearing house officials were busy trying to determine the precise extent of the exchange's exposure to Barings.

Investigations carried on throughout the weekend in both Britain and Singapore.

Over in London, frantic, round-the-clock meetings took place while specialists with expertise in the complex financial derivatives markets were called in to try to make sense of the losses.

On Sunday, efforts to find a buyer for Barings before the Tokyo market reopened failed and Barings officially went bust.

Thankfully, MAS officials had by then determined that Barings' problems in Singapore were confined to only its futures unit. Barings' two other units here - its merchant banking arm and stockbroking house - were not affected by the losses.

MAS had earlier required Barings to trade futures in an entity separate from its merchant banking arm and report directly to Barings London. As a result, the bulk of Mr Leeson's trades had been done for the accounts of Baring Securities (London) and Baring Securities (Tokyo). There was thus no systemic threat to the financial sector in Singapore. BFS was not a bank and did not take in retail deposits.

Dr Richard Hu (former MAS chairman and former minister for finance) recalls: 'When Barings happened, of course, (MAS deputy managing director) Koh Beng Seng and his team were very quick to act. They went immediately to Barings, took the books and discovered how the sequence of events took place. And it was very clear. Leeson was mainly speculating in Nikkei-225 futures and reporting profits which did not exist. As far as the home office was concerned, this unit in Singapore was making money and they provided more funding to increase the size of its business.'

In consultation with MAS, Simex swung into damage control on Monday, Feb27, when markets reopened.

To ensure that market players continued to have confidence in Simex trades, the exchange doubled trading margins, requiring traders to put up more cash upfront.

In a publicly released statement, Simex also said it had taken over the management of all BFS' open positions and was satisfied the margins that it held in relation to the open positions were adequate to cover anticipated price movements.

When BFS' related party customers failed to meet margins calls on Monday, Simex applied to the court to appoint judicial managers to ensure the orderly settlement of BFS' liabilities.

But Simex's announcement to substantially increase margin deposits was unfortunately read the wrong way.

Instead of seeing it as a cautionary prudential move, major US futures commission merchants

(FCMs) took it as a signal that Simex, the key counterparty to the traders of the Chicago Mercantile Exchange (CME), might be short of funds.

Ms Mary Schapiro, then chairman of the Commodity Futures Trading Commission (CFTC), woke Mr Koh with a phone call in the wee hours of Tuesday morning in Singapore to convey these fears.

She told him that the FCMs wanted written assurance from MAS before the Singapore markets opened on Tuesday that the additional margin deposits imposed by Simex would not be used to meet BFS' liabilities.

Ms Schapiro added that if the written assurance were not given, the FCMs would not remit funds and the mutual offset link that Simex had with the CME would be broken. On hearing this, Mr Koh headed instantly to Simex to address the situation, stopping only to brush his teeth.

At Simex, Mr Koh entered into a conference call with US officials, after which he immediately drafted the statement assuring FCMs that their margin deposits at Simex were secure.

'It was 3am in the morning. MAS and not Simex had to guarantee what money that came in would not be used to settle the Barings losses,' recalls Mr Koh animatedly.

'The choice was that if MAS didn't sign, and at that time (the US) market was about to close... Simex would be finished. I signed (the statement), faxed (and) morning came. We survived.'

Former Simex president Ang Swee Tian, who was with Mr Koh during those tense moments, admits that the reactions from FCMs and CFTC's demand for MAS' assurance came as a surprise to him.

'How could market participants have misinterpreted our actions to increase margin requirements?' he says. 'It just shows that in handling any crisis, it is important to communicate clearly to market participants.

'It is also crucial to be sensitive and be able to respond quickly to any unexpected developments so as to ensure that the crisis situation would not be worsened. Simex was fortunate to have Beng Seng around to lead us out of the crisis.'

Following the crisis, MAS again strengthened the legislative framework. MAS and Simex also conducted a thorough review of the exchange's rules, audit and surveillance systems and clearing practices. In a direct response to the Barings incident, Simex directed member firms to ensure that the head of dealing not be in charge of settlements, and that proprietary traders not handle customer business.

Mr Leeson had headed both the dealing and settlement departments of BFS, which meant he effectively controlled both sides of the trading operation - a fundamental oversight by Barings. The exchange also appointed a panel of distinguished professionals and regulators from the international futures industry to advise on how it could be protected from similar crises in future.

Meanwhile, MAS pledged to step up cooperation with overseas futures regulators to better coordinate the supervision of futures trading.

Ultimately, the losses incurred by BFS and the consequent collapse of its parent bank had no impact on the integrity or stability of Singapore's financial sector. Nevertheless, Barings' collapse was a timely reminder of the importance of a regulatory framework that is both effective and proactive, and that keeps up to date with changes in the international financial environment.