WASHINGTON -- Banks may be marketing derivatives aggressively to municipalities and pension funds that in some cases may not have enough expertise to understand the risk, says Heinz Binggeli, managing director of Emcor Risk Management Consulting Corp.
But on the corporate side, most banks aren't aggressively marketing derivatives, Binggeli said in an interview. His firm specializes in fixing the portfolios of businesses and other institutions that have lost money because of dealings in derivatives.
According to a survey of corporate clients conducted by the Irvington, N.Y., firm only 12% responded that their banks had been too aggressive in the marketing of derivatives.
Among those companies, the most common complaints were that their bankers didn't develop a clear understanding of their needs and that the product proposal didn't touch on the potential drawbacks inherent in the instruments. This lack of understanding is seen more often with municipalities and pensions, Binggeli said. Emcor will probably conduct a survey of municipalities and pensions in the near future, he said.
Binggeli said that not only do some state and local governments lack expertise, but the individuals selling the products often don't understand the product.
"The people selling these instruments to the local towns may be less sophisticated than the salesperson selling to General Motors or IBM," Binggeli said. "If you want to sell to these large multi-nationals, you have to be equipped, you have to know your product."
Further, Binggeli said, with respect to pensions, money is often handled by outside managers who don't report on derivatives transactions they are doing for a fund's portfolio. His firm is now reviewing the portfolios of one pension fund that relied on outside management mostly for its investment decisions.
"They basically asked us to review what is in their portfolios because most of the money is managed by outside managers," he said.
He said that while large corporations fell into the trap of investing in products like inverse floaters that haven't had good returns in an environment of interest rate hikes, less sophisticated investors, including some municipalities, also made similar investments.
Hence, Binggeli emphasized the need for standards when dealing with smaller municipalities and pension funds.
"We have to distinguish who the buyers are," Binggeli said. "I think in terms of oversight and disclosure, some more disclosure standards would be beneficial, also more disclosure from the banks in terms of what they sell," he said.
Meanwhile, efforts by Congress and regulators to increase suitability and disclosure standards won't be necessary for the most part, because the industry itself is forming its own standards, Binggeli said.
"To get regulations which restrict the development of derivatives would be a bad move," he said. "I think it should be mostly self-regulating."
He said the industry has already started establishing its own standards.
"With the lawsuits we read about, each financial institution will have to have certain suitability standards. It's going to be in their best interest to do that," Binggeli said. "I'm sure every bank is working on that fight now."
Meanwhile, coming up with proper suitability standards in the industry isn't an easy task, he said.
"It's very hard to come up with standards which should apply to anyone in the public," Binggeli said.
Some municipalities have the expertise to handle investment decisions, but size isn't the only issue in determining that, he said.
"If it's a private individual, it's clear. If it's a large sophisticated pension fund, it's not so clear," he said.
Binggeli cautioned that the recent reports of derivatives losses could result in even more losses if hasty decisions are made.
He said municipalities, corporations, and pensions will lose even more money if they liquidate their derivatives portfolios without considering other options.
In some cases, he said certain investments can be held on to and hedged.
"Certainly it's better to look at them. Some are less risky," he said. "To grab the phone to call a dealer and sell it at any price is not the answer. In many instances, if you get out now you may be selling at the bottom."