Bankers are divided on whether the Comptroller of the Currency's new guidelines on managing risks from derivative products will prove to be a major burden.
The guidelines outline how banks should manage various risks stemming from dealing in derivatives.
Derivatives are financial instruments whose returns are tied to - or derived from - the performance of corporate or government bonds, currencies, stocks, or interest rates.
Bankers say most of the requirements in the 26-page circular are probably already followed by the banks with the biggest derivative-dealing businesses and will not prove to be onerous.
"Quite frankly, we're not worried by this," said Craig Bouchard, senior vice president in charge of derivative products at First National Bank of Chicago. "The attitude the OCC has conveyed to banks such as ourselves is that there's a commonsense way to do this."
But he added that banks will know the effect of the new guidelines only after seeing specific questions posed by the OCC during audits.
Variety of Risks Covered
The OCC guidelines cover how banks should manage risks from adverse changes in market conditions, credit risk posed by counterparties and from other sources, liquidity risk, and operations and legal risk.
The circular, published Oct. 27, does hit one hot button by imposing an obligation on banks to ensure that the derivative products they sell are appropriate for their customers, both banks and other types of corporations.
The circular says banks must "understand the applicability of financial derivatives instruments to the risks the bank customer is attempting to manage. When the bank believes a particular transaction may not be appropriate for a particular customer, but, the customer wishes to proceed, bank management should document its own analysis and the information provided to the customer."
This obligation "is trouble-some," said," H. Rodgin Cohen, a partner with the law firm Sullivan & Cromwell. "It creates the inference that the customer could refuse to perform on the contract on the basis that it wasn't suitable."
Mr. Cohen acknowledges that making that inference is a big step. But "whenever you say that someone has an obligation, it sets up a situation on the other side," said Mr. Cohen. A customer could say it was taken advantage of by the bank, and claim that the bank should have known a derivative was not appropriate, he said.
"If there's reasonableness in the OCC's examination, then it will work out," said Mr. Bouchard of First Chicago. "If there's a great deal required on the motivation of customers on a deal-by-deal basis, it will be onerous."
Just the Beginning?
The new guidelines may be the beginning of a regulatory push for banks to use risk-management procedures created for their derivatives business in other parts of the bank.
Some derivatives dealers have more sophisticated systems for measuring interconnected risks, including credit risk, market risk, liquidity risk, and concentration risk, than those used in other parts of their banks, said a regulatory official.
"There's no reason that they [risk management techniques for derivatives] should not be applied to all of a bank's risk-taking activities, and especially trading activities," said the official. But he said regulators understand that this process "will take time."
Other Trouble Spots
John Peters, a senior vice president for First Union Corp. said regulators are putting special emphasis on guidelines for derivative product risks when more conventional financial instruments be just a volatile.
"There's plenty of volatile stuff out there in the cash market that is being sold to customers and probably shouldn't, and no one's saying anything," he commented.
The OCC circular only applies to national banks, but other agencies may follow suit with similar guidelines.