Derivatives Remain Contentious

Financial News, September 14, 2003 | Go to article overview

Derivatives Remain Contentious


Byline: Natasha de Teran

The legendary investor Warren Buffet's outspoken comments against the derivatives industry generated endless headlines earlier this year. However, while several like-minded columnists and investors echoed his views, there was a noticeable lack of comment from regulators.Indeed, many regulators - and most notably Alan Greenspan, chairman of the US's Federal Reserve - appear to be firm supporters of the industry. Even while the derivatives industry develops apace in the more established markets, regulators in other countries have made active moves this year to see their own markets develop.

Korea has the fastest growing derivatives market in the world; in India whole new families of derivatives instruments have been introduced, and in Russia and China regulators and law-makers are introducing legislation that will propel the market's growth still further.

Not long after Buffet's views were aired in March, Greenspan was speaking at a conference in Chicago, where he reiterated his belief in derivatives as sound risk management tools. He said: "The use of a growing array of derivatives and the related application of more sophisticated methods for measuring and managing risk are key factors underpinning the enhanced resilience of our largest financial intermediaries. The benefits of derivatives, in my judgment, have far exceeded their costs."

Bob Pickel, chief executive of the International Swaps and Derivatives Association (Isda), who spends much of his time dealing with regulatory authorities across the world, says Greenspan's comments were a "positive response" to Buffet, and observes that most other regulators are also more than supportive of the instruments.

Pickel says: "Many of the bank regulators, particularly those that are actively involved in the Basel process, have acknowledged the benefits of these instruments, and have made it known they would like to see banks use them to offload credit risk."

Such is Buffet's sway, however, that the discussion continues. His comments were the subject of a discussion at the annual exchange-traded derivatives industry conference held in Burgenstock earlier this month.

Unable to secure Buffet or an alternative spokesperson to defend his tenets before so many staunch derivatives supporters, John Langton, chief executive and secretary general of the International Securities Markets Association (Isma) was forced to read out Buffet's comments. Unsurprisingly, they found little sympathy.

One of those speaking on the panel was Roy Leighton, chairman of the European advisory board at Credit Lyonnais, and the European Futures and Options Association (FOA). Although Leighton acknowledged that derivatives indeed have the potential to do serious damage, he was swift to add that this was only the case in the wrong hands or control environment.

He said: "In today's environment that it is a remote possibility. The standards that go into vetting and hiring and educating those operating in these markets is very high. A modern trader is subject to as much post-qualifying education as any other professional. Similarly, the control environment today is well developed; exchanges, regulators and clearers form a formidable array of defences."

The only area of potential danger that Leighton pointed to was in the over-the-counter (OTC) area of the derivatives business - a market that the Bank for International Settlements (BIS) estimates to have been worth in excess of $140 trillion ([euro]126 trillion) at the end of last year. The OTC business has recently outpaced growth of the exchange-traded business. During the second half of last year the market grew 11% from the $127. …

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