"Time and chance happen to all things."

Ecclesiastes 9:11

With this passage from the Old Testament, Gay Evans lauded the growing usefulness of financial derivatives in her keynote address to the International Swaps and Derivatives Association's New York meeting in July.

Time and chance may do their worst, said ISDA chairman Evans, who's also a managing director in London for Bankers Trust International plc, but with derivatives "the pain need no longer happen to you." For Evans and other practitioners of the financial black-box arts, derivative instruments like swap and options are simply proven and effective tools for limiting exposure to volatility in interest and exchange rates and commodity prices.

Dealers were especially heartened when the Basel Committee on Banking Supervision recently amended its rules to allow the use of netting formulas in calculating capital adequacy. Previously, adequacy was calculated contract by contract, and this should enable dealers to do more business. But the change also concerns James Bothwell, director of the financial institutions and market issues section of the General Accounting Office, and one of the principal authors of the report the GAO released this spring. First, this will lead to greater volume just as regulators here and overseas are growing increasingly alarmed over the size and extent of the derivatives markets. Secondarily, the legality of netting contracts themselves--which go into effect when a party to derivatives' contract is declared insolvent--has yet to be established via a court decision.

The risk is not to be taken lightly. The GAO report refers to a British court decision that invalidated the derivative contracts entered into by some local governments in suburban London, and held 75 dealers liable for a total of $178 million. Thus the possibility exists that a dealer could be liable for large an unexpected losses because a netting contract is unenforceable.

Still, most lawyers advising ISDA members believe these contracts are sound, says Linda Klein, a partner with the New York law firm of Debevoise & Plimpton.

The legal and regulatory issues surrounding derivatives have grown to such an extent that were it not for the Clinton Administration's health care initiative and the Whitewater scandal, the entire derivatives business might well have bee Topic A this summer in Washington.

As unpleasant as that scrutiny might have been, it would have been deserved. A few days before the ISDA meeting, PaineWebber Inc. announced it would pump another $180 million into a short-term government bond fund. This came only two months after the firm had shored up the same fund by $88 million. The steps wer necessitated by the fund's heavy losses on derivatives investments that had not been revealed in the fund's prospectus, the latest in a long series of derivatives-related losses this year.

Should an unfavorable court ruling ever snare dealers in nets of their own making, the vagaries of time and chance would look inconsequential by contrast.

One poetic assessment of the risk can be found in the verse immediately following the one Evans cited.

"No one can anticipate the time of disaster. Like fish taken in a cruel net, an like birds caught in a snare, so mortals are snared at a time of calamity."

Ecc. 9:12

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