There are two aspects to this issue - an institution must have sufficient capital to withstand the impact of adverse market moves on its outstanding positions as well as enough money to keep these positions going. Barings management thought that Leeson's positions were market neutral and were thus quite happy to fund margin requirements till the contracts expired. In the end, these collateral calls from SIMEX and OSE proved too much to bear (as was pointed out earlier, they were larger than Barings' capital base) and the 200-year old institution was forced to call in the receivers. It was funding risk that seriously wounded Barings but the terminal shot came from the discovery that the enormous positions were unhedged.
Funding risk also nearly sank Metallgesellschaft, a German industrial company, in 1993. In that year alone, Metallgesellschaft's US subsidiary paid out $900 million in margins for its crude oil hedges on NYMEX. When the American subsidiary asked for a cash infusion to meet further margin obligations, the parent refused and closed out the NYMEX contracts at a loss. The latter only survived because a consortium of German banks quickly put together a rescue package of $2 billion.
Both the Barings and Metallgesellschaft stories highlight the need for institutions to pay more attention to the interim funding needs of hedged and semi-hedged positions. But the parallel ends here. Baring's senior managers continued to fund Leeson's activities because they thought they were paying margins on hedged positions (as well as those of their clients) whereas they were actually losing money on outright bets on the Tokyo stock market. Metallgesellschaft, on the other hand, refused to grant any more interim finance because they thought they were losing money on contracts which were infact bona fide hedges for the company's long-term obligations. Both incidents illustrate the need for senior managers to be more knowledgeable about hedged positions because the issues facing them are complex in many cases.
As it turned out Barings had significant market risk from its naked positions so even if it had managed to borrow enough money to cover its margin costs till the contracts expired, it would have been unable to withstand the substantial losses it would suffer on expiry. Agents appointed by Barings' administrators closed out the contracts at losses totalling US$1.4 billion, so Barings' inability to meet its margin obligations at the end of February just hastened its demise. Its fate had been sealed at the end of January when Leeson had an unauthorised Nikkei exposure of about 30,000 contracts.
