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The Earl of Longford: My Lords, is derivative trading another term for speculation or gambling?

The Viscount of Falkland: My Lords, as I understand it—and others better placed in this debate will correct me if I am wrong—derivative trading is a cover-all term for sophisticated products, as they are now called, although there is no product; that is the

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jargon. Sophisticated markets are made in order that institutions, rich individuals and international banks can look at their portfolios and decide that, in order to spice them up, they will involve themselves in such dealings, whether it is in commodities, the rise and fall of indexes or the more complicated options. I hope that I have described that to the satisfaction of the noble Earl, but I am sure that others will amplify that explanation.

It seems that Mr. Leeson was doing that. As his statements have been published in the newspapers, they have been extremely interesting. A minor aspect of the affair is that I should like to know how is it that Mr. Leeson ends up in Frankfurt? Apparently, he spent some time trying to cover his losses. He had the most extraordinary role in Singapore. Not only was he the principal trader; he was acting as the accountant and compliance officer. It was a one-man band of the most extraordinary kind. He was sending back information as regards the true situation to a very small group in London. But he stuck it out, trying to create margins in order to continue trading. It all became too much for him and I understand that he ran to Malaysia. We may never know whether he was acting on his own behalf, but I hope that that will come out at the inquiry, which I am sure will take place.

What worries me—and this must worry the Serious Fraud Office and other people in the banks—is what will happen if Mr. Leeson goes to Singapore. I should prefer that he came here. Many people may wish him to be tried in a country where the judges are not independent and the gaols are extremely uncomfortable. I should prefer him to go to Ford open prison so that we have proper declarations and revelations which will enable us to base our future decisions on how such dealings and rogue traders, if that is what Mr. Leeson is, should be dealt with.

I admit that I am raising trivial matters compared with the broader picture given by the noble Lord, Lord Eatwell. I believe that there are many unanswered questions which relate to the day-to-day business of the City of London. Investors, whether here or abroad, and financial institutions will be uneasy until all those questions are answered.

The Bank of England and the Government have successfully bailed out two secondary banks in recent years, after a good deal of discussion in your Lordships' House and elsewhere. But this bank, a primary bank—indeed, one of the leading acceptance banks in the world and one of the blue chip operators in the field—has disappeared and is now in the ownership of a Dutch company. There are many questions to be answered.

I shall not bore your Lordships any longer with any of the gossip which I have managed to pick up during my investigations for today's end-of-term debate.

Noble Lords: Oh!

The Viscount of Falkland: My Lords, I shall, however, give the House one piece of gossip because it is the end of term. Apparently there was a very brilliant operator in Barings. Although I had met him, I did not know that he was that brilliant; but I did know that he was very rich. He made a lot of money and many bonuses for Barings, but he fell out with his fellow

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directors for reasons about which I am not quite clear—some financial and some personal, as I understand it. His departure from the bank left a great gap, so that people less expert than he was stepped into his position.

Mr. Leeson was a lucky young man. Indeed, the City of London now depends upon variably competent or incompetent compliance officers—bright young men, often from what we call the "estuary" part of England, who are quick, ambitious and hard working. Mr. Leeson made a good deal of money and great bonuses for his employers; in fact, we are talking in lottery figures of an enormous kind. When someone becomes used to such luck, not only does he want it to continue, but, he who creates that luck begins to think that he is immortal. Of course, the fall inevitably comes and that is what happened to Mr. Leeson. I believe that that will be revealed when the full inquiry takes place.

Seriously, it is a shabby business and one which is damaging to our country and to the City of London. We shall not get over it easily. It needs to be dealt with in a serious manner by an independent inquiry as the noble Lord, Lord Eatwell, said. I hope that it happens in short order and that we do not have any more bland statements, either from the Bank of England or the Government, on the matter.

Moreover, as we are at the end of term and we can be naughty because we will be away for a few weeks—or, indeed, for a few months—I must say that I think the behaviour of the Governor of the Bank of England has been extraordinary by the standards of normal, government servants at a high level. If I may put it this way, he seems to have taken an aggressively defensive stance, lashing out at any criticism from anywhere—whether it be from an MP, a Treasury Select Committee or the press. If I may say so, and although I do not know the gentleman personally, his attitude has certainly been lacking in grace and has not been appropriate to the gravity of the situation in which the Bank of England now finds itself. I hope that his tone will change in the coming weeks. I am quite sure that, if we have an independent inquiry, he will be forced to change his attitude.

I have finished my speech. However, I should just like to wish all noble Lords, including the Minister who is to reply to the debate, a very happy summer.

2.33 p.m.

Lord Spens: My Lords, as regards the comments of the noble Lord, Lord Eatwell, about complacency in the structure of the Bank of England, I believe that he is probably slightly wrong. The structure of the Bank of England suffers from a different form of problem; namely, the problem of papal infallibility. Every day I cannot help but feel that my old friend Mr. George looks more and more like some sort of Pope who is not subject to any form of criticism and is finding it very difficult to take.

I want to talk a little about the structure of the supervisory function in the Bank of England as it stands today and say why I consider it wholly wrong for it to continue into the future. I first met the supervisory structure—best summed up on page 269 of the report—

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and the individuals in it in 1982. Without exception, they were all one rung lower then but they seem to have moved up in tandem.

When I first joined a small merchant bank it became clear to me that it was to all intents and purposes broke. It had a loan portfolio which did not pay for itself in interest costs; it had an overhead that was too big; it had a bad debt problem on a scale to its portfolio that represented something like 30 per cent.; and it had no share capital. In discussion with this team, from top to bottom, it became clear that they had no idea how a small commercial bank operated, the business it did, or how it conducted life at all. While we went out to find new share capital, they made great efforts to obstruct what was going on.

Eventually we found new share capital and we brought some £70 million of new share capital into that small bank and wrote off £30 million of loans. These were loans which were shown on the balance sheet as on overdraft and therefore money at call. They were all to small furriers and people like that in the City who were also going out of business. It was therefore quite clear that the balance sheet was not showing the truth. None of these loans was likely ever to be repaid on call, if they were to be repaid at all. The supervisory department had no idea of this problem.

Before I go any further I should confess to a slight passing interest in the Bank of England. It will come as no surprise to everyone in this House when I remind them that I am currently in action against the Bank of England for the tort of unlawful interference in contract. Therefore I am prohibited from continuing much further down the line while that is sub judice.

All I can say—I think this is not in dispute—is that the method of regulation and supervision that took place in those days in 1987 was by ultimatum; in other words, the bank was told, "If you do not get rid of Lord Spens by 11.30 this morning, you will lose your banking licence tomorrow". Indeed, 10 directors of Morgan Grenfell went like that. I suspect that one of the reasons that no director of Barings has gone like that is my action against the Bank of England where I stated that this was unlawful behaviour by the Bank.

We shall not know for some time whether that is the case, and it is unfortunate that my case has taken such a long time to come to court. However, it will come to court in due course. I class this as a form of blackmail supervision. If one looks at the record of the Bank of England in its supervisory capacity, apart from the three big ones, Johnson Matthey, BCCI and Barings, there are some 20 to 30 other major failures. There is, for example, the Bank of Wallace Smith and Co. which went under for some £100 million three years ago. The chairman of that bank is currently a guest at Ford Open Prison. What is interesting about that case is that the Bank of England was informed by the auditors that they were unhappy with the fee income as shown in the accounts of that bank and they thought it was bogus.

The Bank of England, under its powers given by the Banking Act 1987, commissioned a Section 41 report, which it is entitled to do, which showed that the income was indeed bogus and did not exist. Did the Bank do anything about that? No, it did not. A year later the

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chairman of Wallace Smith, Mr. Duncan Smith, walked into the Bank of England one weekend and said, "I am bust to the tune of £100 million". Admittedly it was a wholesale bank and therefore there was no great fuss about it.


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