Two tangles ahead: risk management and corporate governance.

• Author: Boyle, Richard J.

Two tangles ahead: risk management and corporate governance

In the last few years, the world's attention has sharply focused on the rapidly and utterly unpredictable pace of political change around the globe. This geopolitical evolutions for the global implications for the global economy of the 1990s, and I'm afraid these implications are not yet fully appreciated.

Lifting currency controls in Romania, granting most-favored nation trade status to the Soviet Union, extending Poland duty-free access to many U.S. markets, and increasing East/West joint ventures are just a few exampels of what I think is ahead.

To manage the challenge, financial officers and portfolio managers will need skill, knowledge, and, of course, the best available resources. And they'll need to understand what are becoming two very important areas in corporate positioning: risk management and the changing trends in corporate ownership.

Risk on the rise

It's a safe assumption that the relatively stable environment of the 1950s and '60s is gone forever. Over time, our own commercial prime rate has been a barometer for change. For instance, during the 1930s and '40s, there was a 13-year span with absolutely no change in the rate. It changed only 15 times in the entire decade of the 1960s--all from 166 on--and the total change was within a range of 3.5 percentage points. However, in the 1970s, the prime rate changed 135 times and varied as much as 1,100 basis points. Then, in less than five months in 1980, the prime soared from 10 to 21.5.

Managing an enterprise when markets undergo fluctuations as wide and as frequently as these becomes extraordinarily risky. New tools have to be invented to hedge against these risks. And the uncertainty about the future price of basic commodities, notably crude oil and certain mineals, also has led to more innovative methods for managing commodity price-related risk.

Today, more efficient risk management products are avaialable to offset a company's vulnerability to unpredictable rate prices and value fluctuations. And, in the 1990s, for managers to leave a company or a portfolio at risk would be as fool-hardy as refusing to take out fire insurance on their own homes.

This is not to say that the risk management products of a financial intermediary are essential in every case. Treasurers of large global enterprises carrying both positive and negative exposure in a variety of currencies sometimes can engineer their own internal hedges. But even large multinationals with internal hedging strategies find it prudent to cover occasional unbalanced exposures with swaps and other techniques.

Fiduciaries and companies with more limited portfolios and those who tap capital and currency markets only occasionally have a correspondingly greater need to hedge their exposures.

New and improved

Most of you are familiar with conventional risk management products such as swaps, caps, and options. Some of you may also be using the next generation of derivative products: captions, which are options to buy or sell a cap, and swaptions, which are options to enter into or terminate a swap. The accounting for these products is esoteric.

Demand for the full range of these risk management products is growing. The market and interest rate and the currency swaps had outstandings estimated to surpass $1 trillion at the end of 1989.

Currency swaps are also growing rapidly as issuers and investors increasingly tap world markets. Cross-border security transactions increased at 43 percent compound annual rate throughout the 1980s and exceeded $4 trillion last year.

The commodities swap market is a much more recent development. We covered 60 million barrels of oil outside the...