"The Equitable Life: Boards sued for not using derivatives"
10 September 2000, The Sunday Times, London
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In my book "Key
financial instruments: understanding and innovating in the world
of derivatives" (Feb 2000 Financial Times Prentice Hall),
I pointed out that
"boards have been successfully sued for not using
derivatives". I also asked
"why did they <The Equitable> not manage the interest
rate risk either by
altering the duration of their investments in fixed-rate government
securities
or by re-insuring. <through derivatives>? The losses in
the Equitable case dwarf
those that arose <in banks> through using derivatives."
They could even have
set up of a captive interest rate derivatives unit to
manage the risks under the guaranteed rates policies.The beauty
of
the derivatives or re-insurance market is that one man's risk
is another's
diversification reward. Furthermore, there are many classes of
borrowers that
benefit from lower interest rates. Variable rate mortgages, bank,
corporate or
government bonds which included minimum interest rates could have
been used as a
source of interest rate insurance. Perfect hedging at a reasonable
cost would,
indeed, have been impossible. But risks could have been better
managed. And
adding together lawyers' fees, the value of the loss of reputation
for "fair
play", increased advertising spending and, inevitably,demutualisation
fees we
would get a figure far in excess of derivative-writers' profit
margins.
There remain some
interesting questions that I have not seen answered. What
valuation, at the time of marketing and sale, did the Equitable
place on the
interest rate guarantees provided ? Did they obtain external valuations
of such
guarantees in the derivatives or capital markets? What strategy
did they put in
place to manage the risks once they had chosen to self-manage
them? What
valuation did the Equitable's auditors place on the liabilities
inherent in
these guarantees? And most interesting - what did these auditors
make of the
nature of the guarantees provided at the time they were given?
Warren Edwardes,
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