THE VIRGINIAN-PILOT
Copyright (c) 1995, Landmark Communications, Inc.
DATE: Tuesday, February 28, 1995 TAG: 9502280238
SECTION: BUSINESS PAGE: D1 EDITION: FINAL
SOURCE: BY TOM SHEAN, STAFF WRITER
LENGTH: Medium: 72 lines
The collapse of British investment bank Baring Brothers from derivatives-related losses will prompt calls in the United States for increased scrutiny of the complex contracts, finance professors at Virginia universities predicted Monday.
``For those people waiting to trash derivatives, this is one more piece of ammunition,'' said Don Chance at Virginia Tech's Pamplin College of Business in Blacksburg.
But most American banks and securities firms trading these contracts have more sophisticated controls over their derivatives activity than Barings apparently had, Chance and other finance professors said.
Derivatives are contracts whose values are tied to the price of an underlying stock, bond or index, such as the Standard & Poor's 500 Index of stock prices. The contracts often involve bets on the direction that the prices of stocks, bonds or particular commodities will take.
Many companies, including banks, auto manufacturers and oilcompanies, routinely use derivatives to limit their exposure to fluctuations in interest rates and currency prices. However, derivatives also can be used to speculate on changes in the financial and commodities markets.
Scores of large corporations, mutual funds and municipal governments attracted attention last year after losing money on derivatives that failed to work as expected. Orange County, Calif., for example, declared bankruptcy after losing more than $1.5 billion on bond investments that were tied to derivatives.
Members of Congress have been reluctant to impose restrictions on the use of derivatives, partly because Federal Reserve Chairman Alan Greenspan and other bank regulators have testified that their agencies have adequate supervisory powers.
But after the publicity about derivatives-related losses at Procter & Gamble Co. and Orange County last year, ``the derivatives issue is on everybody's mind,'' said Larry Pulley, a professor at the College of William & Mary's School of Business Administration in Williamsburg. ``My concern is that there is a tendency to overreact.''
The $1 billion in losses that Baring suffered before its demise over the weekend will likely heighten concerns even more, said Mark R. Eaker, a professor at the University of Virginia's Darden Graduate School of Business Administration. ``Some people will say, `Gee, it happened to this British firm, so it could happen to an American firm.' ''
However, derivatives-related losses of the sort Baring suffered is unlikely at an American bank or securities firm because of the internal controls used by U.S. institutions, Eaker said.
Still, the Baring debacle will spur some American banks and securities firms to look more closely at their controls on derivatives trading, he predicted.
``If I were the chief executive officer of any sort of financial intermediary, whether a bank or a securities firm, I would be on the phone today,'' Eaker said. ``I would want an assessment: `What are the odds that someone could do this to us?' ''
In a speech to the Economics Club of Hampton Roads last Friday, the global head of derivatives trading at First National Bank of Chicago said that corporate demand for derivatives had slackened in the wake of publicity about derivative-related losses at Procter & Gamble and other companies.
However, interest in the use of derivatives to reduce business risks has spread to such industries as property-and-casualty insurance and electric utilities, said Craig T. Bouchard, the derivatives head and senior vice president at the Chicago bank.
Some insurers have investigated the use of customized derivatives to limit their exposure to weather-related losses on properties they insure. And utilities have been examining derivatives to protect themselves from fluctuating prices of electric power, Bouchard said. by CNB