Bankers: SEC Derivatives Rule May Stunt Risk Management

Bankers are worried that a recent government rule requiring them to disclose more information about their derivatives portfolios will stifle the development of new risk management techniques.

In addition to disclosing data about the types of derivatives held, the new Securities and Exchange Commission rule will require financial institutions to use at least one of three specific methods to compute risk. The results must be reported in institutions' financial statements.

International Swaps and Derivatives Association chairman Gay Evans said the regulation may limit the development of new ways to manage and measure risk.

"Locking in a specific standard today could inhibit the continuing evolution of risk management," said Ms. Evans, who is also senior managing director of Bankers Trust International.

"The SEC didn't take into consideration that corporate disclosures are improving so rapidly that shareholders today receive information that wasn't available to management five years ago."

The rule has caught the attention of Congress. Sen. Phil Gramm, R-Tex., has scheduled a hearing on it Tuesday that which will also address a broader Financial Accounting Standards Board proposal that would force banks to report the fair market value of derivatives in their financial statements.

Bankers have been arguing that the FASB proposal-which is expected to be finalized by June-would distort financial statements by making earnings appear more volatile than they really are.

Both the FASB proposal and the SEC rule are designed to give investors a more accurate picture of corporations' financial condition and the ability to compare performance. But Sen. Gramm, who leads the Senate Banking Committee's securities subcommittee, has received so many complaints from derivatives dealers and users during the last year that a hearing is warranted, according to a subcommittee staffer.

The SEC rule would require institutions to explain how they manage market risk and describe in a footnote to the financial statement the accounting method used for derivatives.

Under the three ways to compute risk in the SEC rule, banks could:

Categorize by maturity dates the values and contract terms used to determine future cash flows of derivatives.

Gauge how changes in market rates would affect future earnings, values, and cash flows.

List the probability of potential losses in earnings, values, or cash flows resulting from market changes over a specific period of time.

Jonathan M. Boylan, senior vice president of financial risk review at KeyCorp, Cleveland, said the new rule won't work.

"Even if the SEC gave us one choice instead of three, each bank's risk models rely on different underlying assumptions, so there'll still be a big comparability problem," he said. Besides, he added, the complicated data in the disclosures will be unintelligible to the average investor.

"This isn't going to resolve the ignorance of investors," he said.

However, some risk-management consultants said that requirements are a necessary step in the right direction.

Heinz Binggeli, president of Global Investment and Risk Advisors, Larchmont, N.Y., said most institutions already use one or more of the three methods required by the SEC rule.

"There has to be some move toward standardization," Mr. Binggeli said. "That has been the point of financial statements: enabling investors to compare the results of different companies. Anyone concerned about risk would have used these techniques before."

The SEC rule, released Jan. 31, is effective June 15 for banks, thrifts, and securities firms with at least $2.5 billion of capital. All other financial institutions have an extra year to comply.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER