12 big financial institutions agree to regulate derivatives

Though blessed by U.S., critics liken move to fox guarding henhouse

Investing

January 07, 1999|By NEW YORK TIMES NEWS SERVICE

WASHINGTON -- With the blessing of the federal government, some of the world's largest financial institutions reached an agreement yesterday to try to set their own industry-wide standards in the huge and volatile market of complex securities known as derivatives.

By setting its own voluntary guidelines, the industry hopes to both prevent recurrences of the problems that have arisen in the derivatives markets and keep stricter regulations from being imposed by Washington. But previous attempts at self-regulation in the derivatives markets have met with limited success.

They did little to stave off the near-collapse in September of Long-Term Capital Management LP, the huge Connecticut hedge fund. Long-Term Capital had invested heavily in derivatives, which are financial contracts that are supposed to manage a company's risks, particularly during turbulent changes in the economic climate.

Executives involved in crafting the agreement, which will be formally announced today, said the group would begin to write a set of industry guidelines by late spring, governing everything from trading practices to lending standards and disclosure requirements.

The agreement was reached in Manhattan at a meeting of top executives from 12 leading foreign and domestic institutions and senior federal officials, Arthur Levitt Jr., chairman of the Securities and Exchange Commission, among them. The agreement was warmly embraced by Federal Reserve Chairman Alan Greenspan and Treasury Secretary Robert E. Rubin.

Rubin heads an interagency group considering what changes are needed in the largely unregulated and steadily growing market in derivatives, so named because their value is derived from underlying products such as stocks, bonds or currencies.

It also illustrates a decided policy position by the Treasury Department and regulators that both the underwriters and the traders of these financial instruments have a pivotal role in policing themselves, a view shared by Wall Street.

Thomas A. Russo, an authority on derivatives regulation and managing director at Lehman Brothers, one of the companies serving on the group, said the formation of the group "is highly significant and a credit to the government regulators for encouraging a private initiative to have global best practices in the risk-management area."

But some analysts disagree and are either critical of the effort or skeptical of what it would ultimately achieve.

"I think it's the fox guarding the henhouse," said Charles Peabody, a banking analyst with Mitchell Securities Inc. in New York. "There's an inherent conflict because you won't police something too carefully if you're making a lot of money on it. That was the lesson of Long-Term Capital, and that's why you need an independent outside regulator."

Government officials and industry executives praised the idea yesterday.

Most of the industry group's members were involved in the bailout of Long-Term Capital. The hedge fund, which borrowed heavily and threatened to wreak havoc on financial markets when its investments soured, was rescued by Wall Street at the intervention of Federal Reserve Bank of New York.

Several companies involved in the new group have recently taken significant hits on their earnings from their investments in Long-Term Capital or their investments in derivatives, despite the intended role of derivatives as a tool of risk management.

Pub Date: 1/07/99

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