Background to BFS's trading activities

1.33	BFS, a Singaporean registered company, was an indirect subsidiary of BSL. BFS was originally formed to allow Barings to trade on the Singapore International Monetary Exchange. At the time of collapse BFS employed 23 staff. BSL's other significant Singaporean subsidiary was Baring Securities (Singapore) Pte Limited (B S S) which employed some 115 staff. B S S's principal activity was securities trading.
1.35	From late 1992 to the time of the collapse BFS's General Manager and Head Trader was Nick Leeson. Prior to this move to Singapore in March 1992, Leeson worked for Barings in London in a back office capacity for almost three years.
1.36	Barings sought to control and manage its operations by means of a 'matrix management' system, a not unusual method of management control for financial businesses which have global operations. Managers who are based overseas often have local reporting lines (typically of an administrative nature) as well as reporting lines to a product manager (who may be based at the business' head office or a regional office.) Leeson reported to Barings' management in Singapore for BFS's office infrastructure, in particular to Mr James Bax, Regional Manager South Asia and Director of BFS, and to Mr Simon Jones, Regional Operations Manager South Asia, also Director of BFS and Chief Operating Officer of BSS. Jones and the heads of the support functions in Singapore also had reporting lines to the Group-wide support functions in London. Whilst there was some debate about Leeson's precise reporting lines from 1 Jan 1994, for product profitability, Leeson reported to Mr Ron Baker, Director of BB&CO and Head of the Financial Products Group (FPG) of BIB, via Ms Mary Walz, one of Ron Baker's London based managers and also Director of BB&CO and Global Head of Equity Financial Products, BIB.
1.37	From mid-1992 BFS executed trades on Simex in Singapore and the Osaka Stock Exchange, Tokyo Stock Exchange and Tokyo International Financial Futures Exchange (all in Japan). BFS primarily executed trades in three kinds of financial futures contracts (namely: the Nikkei 225 contract, the 10 year Japanese Government Bond (JGB) contract and the three month Euroyen contract), and some options on those same financial futures contracts.
1.38	BFS's original function was to execute trades on behalf of Baring's clients. Most of these clients were clients of either BSL or BSJ, and the trades were booked by BFS in the name of BSL or BSJ. This is commonly known as 'agency' business and was managed by Mr Mike Killian, Head of Global Equity Futures and Options Sales, BIB, from Tokyo and latterly the United States. BFS would generate revenue from the commission it charged clients for this type of trading. Barings' records show that in mid- 1993 BFS began to generate profits from trading for Barings' own account ('house' or 'proprietary' trading ) by purporting to take advantage of price differences between SIMEX contracts and the equivalent contracts on the Japanese markets. This is commonly recognised as a form of arbitrage trading, and was called 'switching' business by Barings.
1.41	Until the collapse, Barings' management in London believed the trading conducted by BFS to be essentially risk free and very profitable. They believed that BFS entered into equal and opposite matched positions on a particular contract on SIMEX and one of the Japanese exchanges, and reasoned therefore that the net value of the two holdings would not be affected by price movements on the exchanges.

Indicators

1.68

This report identifies a number of warning signs which were available to Barings' management concerning the nature of the activities undertaken by BFS. The most significant indicators are set out in 1.70. The indicators vary in their weight and an individual item, taken on its own may not have raised alarm. Taken together, however, we consider that they provided Barings in Singapore and London (some of them during 1993 and 1994, and all of them by January/February 1995) with significant warning signals of the danger to which it was exposed.

1.70

The indicators as identified by the inquiry are: (a) The identification of the lack of segregation of duties in BFS between front and back offices, which were subsequently reflected in the internal audit report following the review of BFS's operations which was conducted in July and August 1994; (b) The high level of funding required to finance BFS's trading activities; (c) The unreconciled balances of funds (the'top up' account) transferred from Barings in London to BFS for margins (d) The apparent high profitability of BFS's trading activities relative to the low level of risk as perceived and authorised by Barings' management in London; (e) The discovery of the purported transaction relating to an apparent receivable of Y7.778 billion (approximately £50 million) from one customer, Spear Leeds Kellogg of BFS as at 31 December 1994; (f) The letter sent by SIMEX to BFS on 11 January 1995 (which was not communicated to London at that time), which included specific reference to account '88888' and its large funding requirements; and the letter sent by SIMEX to BFS on 27 January 1995 (which was communicated to London) in which SIMEX sought assurance regarding BFS's ability to fund its margin calls should there be adverse market movements. (g) Issues and questions arising out of Barings' reporting of large exposures and client money to supervisors and regulators; (h) The high level of inter-exchange arbitrage (or switching) positions without any application of gross limits; and (i) Market concerns circulating in January and February 1995.