City & Business: Learning new lingo

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The Independent Online
WE'VE been banging on in these pages for months about the potential dangers of derivatives - those mysterious financial instruments that allow investors to take huge positions in the currency, commodity, share and gilts markets. The deals worldwide are now measured in hundreds of trillions of pounds - far larger than the physical markets they're based on. Many companies have already taken a tumble, including Glaxo, Procter & Gamble, Metallgesellschaft and Allied-Lyons.

Yet company chairmen still trot out stock responses to questions about the risks their treasury departments take on derivatives. They 'never speculate', they 'minimise exposure' to adverse price movements, they are 'prudent and conservative' in their use of derivatives, and they only invest in instruments they understand.

These woolly claims are at best meaningless and usually misleading. But it is refreshing indeed to hear an expert saying as much. According to Neil Record, chairman of Record Treasury Management, these responses tell us virtually nothing about the true risks companies are taking on.

Mr Record is no alarmist scaremonger. A former Bank of England official, he worked in the Mars Group treasury before founding his own highly successful consultancy and currency management group. He now advises many of Britain's largest companies on treasury management.

'No chief executive will admit that his treasury speculates with his company's money,' he says. 'But plenty of treasuries do in practice take bets on currency and interest rates. I would go further and say that practically all the treasuries I have ever come across have done this in one circumstance or another.'

He believes the lack of understanding of derivatives will prove to be the undoing of some companies, banks and even governments. Much of the problem comes down to language. The only accurate, unambiguous and value-free way of explaining derivative positions is mathematics - mathematics of a complexity understood by no chief executives and practically no finance directors.

'While this state of innumeracy exists, then brace yourselves for more disasters,' he warns. Food for thought.