Brokers will volunteer information about risks

March 10, 1995|By Los Angeles Times

WASHINGTON -- Hoping to head off a congressional crackdown on derivatives, the six investment banks that dominate sales in the complex field yesterday announced a voluntary agreement to provide federal regulators with detailed information on their trades, risks and customers.

They also proposed to improve their disclosures to their own clients of the risks and nature of the esoteric transactions.

Had similar early warning systems for management been adopted by the supervisors in Orange County, Calif., or the top officials at Barings Bank in London, the likelihood of the catastrophic financial failures there would have been "considerably lower," said E. Gerald Corrigan of Goldman Sachs & Co., chairman of the voluntary industry group and a former president of the Federal Reserve Bank of New York.

Goldman Sachs, as well as Morgan Stanley, CS First Boston, Merrill Lynch & Co., Salomon Bros. and Lehman Bros., will file voluntary reports with the Securities and Exchange Commission and the Commodity Futures Trading Commission. The companies together handle more than 90 percent of the derivatives business.

By agreeing to self-regulation, the banks are clearly hoping to forestall action in Congress to control the use of derivatives, which have been linked to a succession of spectacular financial losses in recent months.

Congress, remembering the $150 billion already spent for the rescue of failed savings and loan associations,is concerned about the potential disruptive threat of derivatives to banks and associations insured by the taxpayers and the chances that losses could spread to the financial system in general.

SEC Chairman Arthur Levitt, whose agency helped draft the new rules, said yesterday that self-regulation offers the best approach to managing derivatives risk.

"I have resisted seeking a legislative fix to this problem, partially because, frankly, I would not know precisely what to ask for in that connection," he told a news conference at which the agreement was announced.

Derivatives are financial instruments whose value is derived from an underlying stock, or bond, or a commodity or financial index. These might be the interest rate on Treasury bills, the Standard & Poors 500 stock index or the price of crude oil.

For example, the collapse of the British merchant bank Barings resulted from losses in its immense holdings of futures on the Nikkei 225 index of Japanese stocks; the futures represented a bet that the stocks would rise, and the bank incurred nearly $1 billion in losses when they fell.

What particularly concerns regulators and other market experts are so-called "over-the-counter" derivatives -- that is, specialized transactions designed by special departments at the six large banks and others for sale to individual customers or institutional investors.

Because these deals are not easily broken down into futures and options traded on regulated commodity exchanges, their prices and thus their risks can be nearly impossible to fix. That's especially true when the underlying markets move sharply and unexpectedly, as in a financial crash.

The six banks agreed to report each quarter their 20 largest derivatives deals, the partners with whom the deals were made and the potential financial risk from each.

The corporate customers involved in these deals will be identified only by code number. But if federal regulators see the same code occurring repeatedly, indicating an unusually large concentration of activity, they can ask for the name of the customer.

Each bank will use a computer model to provide predictions of the maximum loss in the event of market fluctuations. The computer model will consider the impact of wide overnight swings in interest rates, stock index prices and currency exchange rates as it tries to forecast financial exposure.

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