Some observers were baffled to see Canadian Imperial Bank of Commerce plunge into an expensive buildup of its derivatives business - just when major problems were beginning to surface in the derivatives industry.
Robert Mark, who heads risk management in Canadian Imperial's newly expanded unit, says the black eye derivatives received last year only underscored the need for a big up-front commitment.
"To become a world-class player," he said, "we needed to build the back room - the market risk assessment - to oversee and manage these operations."
The success or failure of Mr. Mark's efforts at Canadian Imperial could well provide an object lesson for regional banks that hope to offer structured finance services to their corporate clients.
To date, Canadian Imperial has spent about $68 million building its support staff and systems.
Management insists the investment was needed to stave off the loss of corporate customers to competitors with expertise in securitizations and derivatives denominated in currencies other than the Canadian dollar. But the move has prompted analysts to reduce earnings estimates for the bank, saying that the investment has been slow to pay off.
"Investors are paying for earnings growth, and this is like a hole in their pockets," said Wendy Gleichmann of Merrill Lynch & Co.
Allyn Keiser, executive vice president and head of global corporate finance at Canadian Imperial, said the buildup was a defensive move.
"We certainly had these products in Canada, but we were losing ground in anything that wasn't based in Canadian dollars," he said. "We're now building this operation so that we will be one of the top competitors in financial products and risk management."
Mr. Mark, a former Coopers & Lybrand partner, was one of the first in a series of high-profile hirings the company made to jump-start its New York- based business.
Among other notable hires was Michael Rulle, who came from Lehman Brothers to head the Canadian bank's global derivatives operations.
Mr. Rulle and his team are charged with creating the products. It is Mr. Mark's job to make sure those products do not get the bank into the kind trouble others have found in these markets.
"The front end is people coming up with solutions for our customers," said Lorne Robbins, head of risk management for the bank's U.S. operations. "But if you do the transaction, the question becomes how much market risk will the institution be taking."
To measure that risk, the company invested in computer systems to link its international branches and give instant information about the amount of risk exposure in its global trading operations.
The information can be sorted by client, industry, credit quality, and location.
Comparing these exposures is difficult, though. For instance, risk measures of a traditional loan may not work well for a swaption or other derivative contract.
To overcome the lack of comparability, Mr. Mark said, the bank is working toward creating a risk measurement, called a common risk unit, or CRU. By having this benchmark, the company can determine the amount of exposure for each product it offers.
The company is taking this information a step further, said Mr. Mark, and attempting to look at its risk position on a companywide basis, not just on a departmental basis. To get there, he said, Canadian Imperial is creating a central depository for data on all contracts and getting risk managers involved at the product-development stage.
"As we go into different kinds of products, we have to be able to quantify the risks we are taking on and be able to bring it down to a common risk language," he said. "We're spending lots of time developing this infrastructure and the data warehouse so that we can go to one place to find out what our risk position is."
So far, the main reaction in the market has been impatience for results.
In a June research report, Hugh Brown with Nesbitt Burns, an affiliate of the Bank of Montreal, praised the company's investment, and urged investors not to give up on the company.
Wendy Gleichmann of Merrill Lynch & Co., however, lowered her estimates for the company for 1995 by 40 cents a share, to $3.60. She said it is taking longer than it should for the company to get a return on its investment in personnel and systems.
This may not be the best way for others to go about setting up their own operations, Ms. Gleichmann added. The length of time it takes to earn a return suggests that acquiring these capabilities may be a better strategy.
"I would think it's more efficient to buy something," she said.
Canadian Imperial's Mr. Keiser countered that the up-front investments are proceeding on schedule and on budget.
Getting the message on risk across an entire organization that spans four continents and more than 10 countries is a daunting task, Mr. Mark said. To avoid the culture shock that an instant changeover can bring, he said, the bank is moving slowly.
Ultimately, he believes the system will give the company the ability to control its position without hindering the product development process.
What's special about Canadian Imperial, he said, "is that it is spending the energy to build a best-practices infrastructure."
And some see signs that activity in investment banking is picking up. Mr. Brown of Nesbitt Burns predicted 1996 earnings will rebound to $4.50 a share, compared with his 1995 estimates of $3.65.