Large UK Companies and Derivatives

Abstract

Derivative securities have transformed the way treasurers view financial price risk and have been used to hedge risks that were previously left open. In this paper, we present the results of surveys of treasurers of large UK companies to questions about their derivative use. We examine the extent of derivative use, the reasons for their use, the perceived risks associated with derivatives, what sort of controls are in place to monitor the use of derivatives, and, finally, reporting practices which govern the disclosure of derivative practices. Results of the surveys indicate widespread use of derivatives like swaps, forwards and options. The primary reasons for their use are to manage interest rate and currency risk. There is a rather limited, but growing, use of derivatives to manage commodity and equity risk. Treasurers report that they are somewhat cautious about more exotic types of derivatives, primarily because of concern over the illiquidity of the underlying market for these derivatives. Interestingly, treasurers revealed that they view control and the nature of their counterparty as the main risks in using derivatives. Finally, the use of derivatives is accompanied by significant control mechanisms inside companies, and treasurers are using sophisticated procedures to quantify their derivative exposures before they are reported at board level.

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