Financial Derivatives: Actions Needed to Protect the Financial System
(Testimony, 05/19/94, GAO/T-GGD-94-151).

Trading by corporations, banks, and governments in
derivatives--financial contracts based, or derived from, an underlying
market, such as stocks, bonds, or currencies--has expanded rapidly
around the globe.  Derivatives have enabled corporations to better
manage the financial risks associated with doing business
internationally and have provided opportunities to profit from swings in
interest rates.  However, much derivatives activity in the United States
is concentrated among 15 major U.S. dealers who are extensively linked
to one another and their customers.  The sudden failure or abrupt
withdrawal from trading of any of these large dealers could cause
liquidity problems in the markets and pose risks to the others,
including federally insured banks and the financial system as a whole.
Federal intervention could involve industry loans or a financial bailout
paid for by taxpayers.  Concerns about derivatives have been heightened
by recent reports of huge losses by some derivatives end-users.
Comprehensive industry or federal regulatory requirements are lacking to
ensure that U.S. over-the-counter derivatives dealers follow good
risk-management practices.  In such a rapidly growing and dynamic
industry, new participants are likely, some of whom may not be as
knowledgeable as current dealers or who may take on unwarranted risks in
an attempt to gain market share or increase profits.  In either case,
systemic risk could increase.  Federal regulators have begun to address
derivatives activities, but significant gaps and weaknesses exist in the
regulation of many major over-the-counter derivatives dealers.  Further
compounding the regulators' problems and contributing to the lack of
knowledge by investors, creditors, and other market participants are
inadequate rules for financial reporting of derivatives activity.  In
GAO's view, the issue is how to allow U.S. financial services to grow
and innovate while protecting the safety and soundness of the nation's
financial system.  GAO makes several recommendations designed to help
Congress, the regulators, and the industry address this issue.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-GGD-94-151
     TITLE:  Financial Derivatives: Actions Needed to Protect the 
             Financial System
      DATE:  05/19/94
   SUBJECT:  Reporting requirements
             Banking regulation
             Securities regulation
             Risk management
             Internal controls
             Financial management systems
             Accounting procedures
             Information disclosure
             International economic relations

             
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