Derivatives study calls for greater controls, fewer risks

An international survey on the use of derivatives concludes that investment funds are needed to improve risk management.

The survey, conducted by Ernst & Young, polled more than 140 investment management companies in Canada, Australia, the U.S., France, the United Kingdom and Hong Kong.

According to the study, as the usage of derivative products increases, many investment funds continue to rely on their portfolio managers and traders to limit, manage and control derivative-

related activities. The survey also concludes there has been a lack of integration between front and back office systems.

“Fund executives and portfolio managers must become more involved in establishing and reviewing policies governing derivatives usage and activities,” says Robert Mitchell, director of Ernst & Young’s mutual fund practice. The creation of independent risk management functions within investment fund companies should be a priority as well.

Almost one-third of the respondents reported using one of the 14 derivative product categories. Of the respondents that favor using derivative products, the most widely used instruments are forward currency contracts. Options include exchange-traded futures on equities, options and interest rates.

The survey results indicate that only one-third of the funds that use derivatives have a supervisory board or risk management committee to establish limits on derivatives usage.