Derivatives include a broad array of financial
instruments that are used by investors, including pension funds, to
efficiently achieve investment objectives. Derivative
instruments are integral to portfolio strategies and are used to
reduce risk, enhance return, replicate physical securities or
achieve a combination of these objectives.
The risk characteristics of individual derivative holdings
cannot be evaluated in isolation, but must be viewed in the context
of the entire portfolio. While derivatives are an important
tool for efficient implementation of investment decisions,
sufficient understanding of the instruments being used and adequate
oversight are necessary.
Plan sponsors have been proactive in developing guidelines and
risk constraints for management of plan assets, and their
derivative exposures are primarily in the more liquid, standardized
and regulated instruments. In addition, CIEBA supports the
Group of Thirty Global Derivatives Study Group
recommendations. These actions demonstrate plan sponsors'
commitment to the responsibilities placed on fiduciaries by ERISA
to manage plan assets prudently and in the best interest of the
Group of Thirty- Global Derivatives Study
In summary, the recommendations suggest that each dealer and
end-user of derivatives should:
Determine at the highest levelof policy and
decision making the scope of its involvement in derivatives
activities and policies to be applied.
Value derivatives positions at market,at least
for risk management purposes.
Quantify its market risk under adverse market
conditions against limits, perform stress simulations, and forecast
cash investing and funding needs.
Assess the credit riskarising from derivatives
activities based on frequent measures of current and potential
exposure against credit limits.
Reduce credit risk by broadening the use of
multi-product master agreements with closeout netting provisions,
and by working with other participants to ensure legal
enforceability of derivatives transactions within and across
Establish market and credit risk management
functions with clear authority, and independent dealing
Authorize only professionals with the requisite
skills and experience to transact and manage the risks, as well as
to process, report, control, and audit derivatives activities.
Establish management information
systemssophisticated enough to measure, manage, and report
the risks of derivatives activities in a timely and precise
Voluntarily adopt accounting and disclosure
practices for international harmonization and greater
transparency, pending the arrival of international standards.
Source: Derivatives: Practices and Principles,
published by the Group of Thirty, Washington, DC, July 1993.
The Group of Thirty is a not-for-profit, Washington, DC-based
research group specializing in international finance.
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