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».
________________

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.