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Summary

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 plan participants.

Group of Thirty- Global Derivatives Study 

Group Recommendations 

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 jurisdictions.

Establish market and credit risk management functions with clear authority, and independent dealing function.

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 manner.

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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bulletTable of Contents 

bulletHow are Derivatives Used? 

bulletIntroduction 

bulletWhat are the Risks? 

bulletExecutive Summary 

bulletSummary 

bulletWhat is a Derivative? 

 

 

 

 

 

 

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