Isda AGM: Buffett’s criticisms of the derivatives market rebuffed

In what turned out to be one of the major themes at the two-day event, held in Tokyo last Wednesday and Thursday, a succession of bankers warned that the negative perception of derivatives perpetuated by high profile figures such as Buffett could pose a potential restraining factor to the future growth of the industry.

“We need to continue to fight energetically to get across to the world at large and the financial markets at large what derivatives are about and what the benefits can be,” said Jonathan Chenevix-Trench, managing director and head of European fixed income, and global head of interest rates and foreign exchange at Morgan Stanley. “I think the combination of tremendous success in terms of growth and a lack of understanding outside of the industry continues to be a danger.”

In a letter to shareholders of his investment company Berkshire Hathaway last month, Buffett wrote that derivatives are “time bombs”, whose “potentially lethal” dangers could threaten the stability of the financial system.

Several derivatives executives have since pointed out that these comments reflect Buffett’s difficulties in closing down Gen Re Financial Products, the derivatives unit of insurance company Gen Re that Buffett acquired in 1999. Having attempted unsuccessfully to sell the derivatives arm to a variety of potential buyers, Buffett has been forced to slowly wind down the business.

“I think a lot of the criticism was coming from the frustration [Buffett] was experiencing in shutting down Gen Re Financial Products,” said Kaushik Amin, managing director and co-head of global interest rate products at Lehman Brothers. “Gen Re was an entity focused on an esoteric area, with very long maturity contracts focused on particular sub-sectors of the derivatives market and it is no surprise that it is very difficult for Buffet to shut it down, especially as he was unwilling to pay a realistic price that you need to pay to exit the market.”

Nonetheless, bankers warned that a continued lack of understanding of derivatives within some sectors of the financial industry, combined with high volatility in the markets, could lead to calls for over-regulation, potentially restricting the growth of the derivatives market.

“It is important in these emotional and turbulent times that regulators and bodies that set standards resist the temptation to over-react and unilaterally set standards that ultimately prejudice the use of derivatives,” said Jerry del Missier, managing director and global head of rates and private equity at Barclays Capital. “And I think it is a responsibility of the derivatives industry and Isda in these difficult times to continue to engage bodies, to push back when we think that they are proposing irrational measures and ensure that we get a sensible oversight.”