Financial weapons of mass destruction

In early March, Warren Buffett (Warren Buffett), referring to the annual message to shareholders of his company Berkshire Hathaway, has called derivatives (derivatives) «financial weapons of mass destruction», «delayed-action bombs, threatening the economy». Is it in this enormous financial industry are so bad? The situation clearly demands explanation.

Guru done noise
Perhaps this call Warren Buffett is not done to much noise, if its author was not a financial guru to fire Alan Greenspan and billionaire with a second state in the world after Bill Gates ($ 30 billion, estimated to Forbes). The broad resonance due to the fact that questions the existence of a key financial industry.

Unlike the spot market on which the calculations for the transactions carried out immediately, derivatives (not quite fitting in Russia called fixed-term contracts) provide for payments in a specified time in the future. And the real gains and losses are determined by the parties contract with one or more parameters whose values prevailing at the time of payment. The most actively traded contracts on interest rates on bonds and bank deposits, stock indices S & P 500, DAX, KOSPI, oil Brent, in gold, on corn and soybean, and more. Contracts can be a little exotic. For example, a contract for the value of the average air temperature in Central Europe in July 2003. In doing so, the vast majority of derivatives are not connected to the supply of real goods, and serves as the main instrument for the sale of risk. Derivatives market - the most visible and rapidly growing part of the global financial system (Fig. 1).


The total value of contracts in use at the end of 2002, according to the Bank for International Settlements (BIS), has exceeded $ 150 trillion. Is Warren Buffett, the sage of Omaha, proposes to abandon all this? There are over what to think, because Buffett does not feel in the refuse. He was one of the few who did not participate in the technology boom in the stock market. In addition, it is not the only critic of derivatives markets. Even Aristotle noted that the various pricing agreements (the ancient version of the derivatives) are used to manipulate prices in the market of olive oil.

Is Buffett right?
To clarify the situation, make a slight digression. The modern market of derivatives, as is known, consists of two fairly independent segments - off (OTC - over the counter) and stock exchange. They have almost no overlap in the instruments used. If the stock market traded in futures and options contracts, but the OTC market accounted for the bulk of the swaps and forwards. In exchange contracts are standardized and can be sold at any time, which ensures high liquidity in the market. In connection with this turns tender exchange contracts reach astronomical sums. Turnover of exchange of contracts for financial assets in 2002 amounted, according to the BIS, some $ 700 trillion. On the OTC market parties are free to choose the type and terms of contracts that provides maximum flexibility, the opportunity to hedge virtually any type of risk, but also leads to the fact that participation in a contract, usually can not be sold to a third party because of the specificity of its terms. Parties have to wait for the expiry of the contract, which can be very large. Exchange derivatives market is characterized by strict regulation by the government, transparency and very low-risk infrastructure. Exchange contracts involve the payment of margin (security), their price can vary only within certain limits during the trading session.

Stock exchanges provide different kinds of insurance funds, and regulators to strictly monitor the financial status of the participants. As a result, for example, for more than 150-year history of the Chicago Stock Exchange Trade (CBOT - Chicago Board of Trade) was not a single case of default of its clearing members. In turn, the off-market derivatives, which exceeds the stock market by volume about five times - is the field of financial innovation, often very difficult and risky. Contents of contracts limited to the imagination (or madness, as Buffett says) participants. It is no coincidence that it is off the market there are problems with potential systemic implications, such as in 1998 at the hedge fund LTCM (Long Term Capital Management), which was forced to help the U.S. Federal Reserve. The second problem - the potential threat of chain of defaults on «the principle of dominoes» because of the involvement in derivative transactions with large number of economic actors.

If the banking sector to prevent such situations, special bodies, in particular the U.S. Fed, in other market sectors, such as insurance, such «central banks» no. The third problem - it is monitoring, regulation and control risks in the rapidly growing market of credit derivatives. For several years in the international system of accounting IAS discussed new rules for accounting transactions in derivative IAS 39 «Financial Instruments: definition and measurement».

From the message Warren Buffett: «When we are with Charlie (Manger, the closest partner of Buffett) finished reading the detailed description of activity of the leading banks in the derivatives market, the only thing to understand is that we do not understand what risks they have taken». And further: «Central banks and governments have not yet found effective ways to control or even monitor the risks arising on derivatives markets».
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One of the key points of the new rules was the best derivatives (fair value), or market value in the balance sheets of companies. Applying this rule would mean that any gains or losses on derivatives directly affect the financial condition of companies and will be made public. Rule IAS 39 has met considerable opposition banking systems of Great Britain, Germany and France. Banks are unhappy that the proposed something similar to U.S. rules with podporchennoy scandals reputation.

Banks also fear that the requirement to evaluate derivatives only at the market price would violate existing scheme of bank risk management. By the way, developers themselves IAS 39 recognizes that it is not until the end of a number of issues, including the still difficult to determine, whether as a result of a financial transaction actually sold to a particular asset or risk. In general, an adequate accounting of transactions with derivatives so complex that the rule of IAS 39, on plans for the Council on International Accounting Standards (IASB), will become mandatory for the single European financial market no earlier than 2007. In this regard, it is not entirely clear on what the rules will take into account transactions with derivatives on the Russian securities market professional participants must move to IAS (IFRS) in 2004.

Lack of transparency
Now, credit derivatives, in which many banks see long-awaited decision means his main problem - control of credit risk. These tools actually arose in response to a series of debt crises, including Latin America. Slabokontroliruemoe and rapid spread of credit derivatives is a major concern of regulators (Fig. 2). Concerns expressed and Buffett.

A recent study by the agency Fitch noted that the actual level of risk in European banks is significantly higher than in their public records, primarily because of the large off-balance sheet obligations of the credit derivatives. The Agency spent three months in an attempt to quantify the participation of various financial institutions in credit derivatives, but succeeded only in part because some institutions had refused to disclose this information. Thus, the obvious problem of this market is its lack of transparency. In addition, according to Risk Magazine, the credit derivatives market is characterized by very high concentrations - to 13 financial institutions account for 80% of Transactions, and the proportion of the two leading players - JP Morgan Chase and Deutsche Bank - was about 40%. Of course, such a high concentration of credit risk among the leading players is potentially dangerous.

From the speech of Alan Greenspan: «This is very complex financial instruments have contributed, particularly over the last two years of stress, creating a much more flexible, efficient and stable financial system than the one that was only a quarter of a century ago. This allowed to survive the bankruptcy of Enron, Global Crossing, WorldCom, Swissair, and the Argentine default, distributing the losses among the banks, insurance companies, pension funds and not causing significant damage the financial system as a whole ».
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In the top of everything in the market, of which only ten years ago almost nobody knew nothing, for a number of derivatives contracts zhevye, mostly long «exotic» contracts, for which current liabilities could not be clearly defined. For example, Buffett says, if the two entered into a contract for the number of twins, born in Nebraska in 2020, both sides can easily show current income on the contract, using different methods of projection. Similar technology has benefited from Enron, podpravlyaya its financial performance and hiding losses. So right there Buffett, calling to renounce the use of derivatives? Not taking the liberty to give a definite answer to this question, we note that the call guru to understand and adequately assess the potential threat of the use of these tools is very appropriate.

Restrict or manage?
Thus, the credit market, and with it, and other OTC derivatives actually carries significant systemic risks. And the main problem is that currently an adequate assessment of these risks is very difficult. It may indeed be to prohibit the holding of such operations, as Buffett suggests? And are there any objective data to prove that the market for derivatives is useful in the macro sense? It turns out there, and very strong. Buffett's opponent inadvertently made Alan Greenspan. In its report in November last year in the U.S. Congress, he noted that the economy and financial system the U.S. has become in recent years, much more stable. Despite the loss of almost $ 8 trillion. market value of shares, a sharp decline in capital investment and the terrorist attack of September 11, went bankrupt or not one major American financial institution! If these events occurred two or three decades ago, it almost certainly would lead to a severe financial crisis and a significant economic slowdown. The main reason for this fundamental change, according to Greenspan - in the wider and equitable distribution of risks in the economy, achieved through the use of new financial instruments. Among them - securitized bank loans (securitized bank loans), interest rate swaps and options (interest rate swaps and options), credit derivatives (credit derivatives) and other tools.

Another indication of the increased stability of the financial system is that it has successfully survived the actual collapse of the telecommunications industry in the stock market. But global borrowing of the industry in 1998-2001. amounted to more than $ 1 trillion. Greenspan acknowledges that the derivatives relate to vysokoriskovannym (highly leveraged) financial instruments, and can in principle cause chain of defaults, but that does not even mention the possibility of restrictions on their use. The main way of controlling systemic risk, which potentially increases with the increasing volume and complexity of the structure of the global financial system is, according to Greenspan, in enhancing the effectiveness of risk management in the private sector, improving national systems of supervision and regulation, development of cooperation between regulators in different countries and to use, finally, the central banks as lenders of last resort. Both points of view, and Buffett, and Greenspan, have a good reason. Yet, apparently, a ban will not solve anything. We need to observe a balance between control (read - constraints) and opportunities for market development.

On the one hand, the systemic risk posed by the market should be controlled by timely and adequate regulation, not very far behind financial innovation. But on the other hand, regulators should be, according to vice-chairman of the U.S. Federal Reserve Roger Ferguson, «at a certain distance from the market, giving him the chance of development».

Cyril Penzin,
Chief Expert MICEX