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The Ethics of Derivatives and Risk Management

Justin Welby1

1 DERIVATIVES

Derivatives are financial instruments based on

other products, whether physical or financial. The
other products may themselves be derivative.
Three main forms of derivative exist: futures,
options and swaps.
1.1

What are they?

Futures Futures originated in the agricultural

markets, with the establishment of contracts for
future delivery of produce. A farmer might sell
next years potatoes now, thus locking in his
return. Derivatives based on physical products
remain crucial and enormous markets, covering
everything from orange juice to oil. A derivative
contract was at this point a contract to take or
deliver a given quantity of a specified quality of
the product at a particular place and time in the
future, and at a price agreed today.
In the 1970s there was a substantial growth in
financial derivatives, starting in Chicago, and
based on instruments such as US treasury bills
and bonds (short or long term promissory notes
of the US government). In the 1980s these derivatives spread geographically, with markets opening in London (LIFFE) and France (MATIF), as
well as the Far East, in Tokyo, Osaka, Singapore
and Hong Kong. All major financial centres now
have a derivatives market. They have also spread
in form, with new contracts being invented. These
have covered all the principal physical products
that were freely traded and most financial instruments. A major innovation was the invention of
contracts based on indices, such as the FTSE-100

(the index of the weighted average value of the

100 largest UK companies listed on the London
stock exchange). It has also become normal to
close out the contracts on the basis of a cash settlement of the difference between the agreed and
delivery price, rather than take physical delivery.
With the rise in the number of different types of
contracts, volumes traded rose rapidly. On LIFFE
in late 1983 an order for 150 contracts of 50,000
nominal value in the long dated gilt future was
huge. Today volume can run to over 60,000
contracts a day. The Financial Times of 6 June
1995 reported volume in the UK of Gilt 35,184;
the German Bund (DM250,000) of 56,027 and the
US Treasury Bond ($100,000) of 629,731.
Options The most important development has
been the invention of the option contract. This is
fundamentally different from a futures contract in
that on the buyers side a right but not an obligation is obtained (other than the obligation to
pay for the option), and on the sellers (technically writers) an obligation but no rights.
Options are based on a complicated mathematical analysis of the volatility of the underlying
product. A buyer of an option is making two
assumptions at least, (1) that the product will
move in value by more than the cost of the option, and (2) that volatility of price movement will
at least not decrease. A writer makes one or both
of the opposite assumptions. A trader of options
should be neutral as to the price but be taking a
position on volatility. The earliest option contracts were in the Foreign Exchange (FX) market,
on the cable (to be traded internationally using
the Atlantic telegraph cable) traded on the

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Philadelphia stock exchange. The market has

developed rapidly so that most large cash contracts and futures contracts now have associated
option contracts.
Swaps The swap market was the last of the
major developments in derivatives. It started in
the late 1970s. Developing rapidly in size, it is
now capable of supporting huge volumes of
transactions and underpins a great deal of the
activity in the international debt capital markets.
In a swap, two borrowers exchange interest
rate obligations. Typically a party with floating
rate interest obligation in a currency (e.g. )
undertakes to pay a fixed rate of interest on the
same amount of principal to a second party with
a fixed rate obligation who pays a rate of interest
to the first party based on an agreed floating rate
of interest. Each has then effectively exchanged
cash flows. Variations on the theme are possible,
for example, across two or more currencies. The
advantages to each side are considerable. They
can manage their exposure to interest rates
without needing to raise new loans, and may take
advantage of good access to a particular market
(e.g., long term fixed interest rate pounds for a
large UK company) without being forced to
remain exposed to that market if they want a
different obligation (for example floating interest
rate US$).
1.2

Where do they happen?

Derivatives markets usually started as exchange

based, linked to a geographical market such as
the Chicago Board of Trade (CBOT). However,
the financial derivatives (and some others, especially gold and oil) rapidly developed over-thecounter markets (OTC), with no physical location.
Major banks act as market-makers and trade the
instruments for their own account. This was especially true in the swaps and options markets. It
led to a deepening of liquidity and flexibility in
the relevant markets and a proliferation of deriva-

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tives of derivatives. Examples are swaptions,

options on swaps, and combinations of different
derivatives intended to cause particular cash flow
effects. This is where it is easy to lose money!
Volumes in the OTC market are enormous. As
long ago as 1989 I was able to carry out the
purchase of an option to buy US$1.5 billion in a
few minutes on the telephone, with one bank.
That would be a large, but not huge, transaction.
The swaps market is even bigger. Almost all
major banks deal in derivatives. Options tend to
be more specialized, owing to their mathematical
complexity, the difficulty of managing the exposure created, and the desire of regulators to ensure that they are properly used.
1.3

Who uses them, and why?

There are three main categories of derivative

user:
Producers Almost all internationally traded
commodities have a futures contract somewhere.
Whether the producers are nations or companies,
they tend to use the derivative markets to hedge
price risk, that is, establish a certainty of future
prices. This may be to protect a producers price
cartel, or simply as a means of avoiding sudden
and unexpected adverse movements. Typically,
producers are the most powerful single group in a
commodity, but not a controlling group.
Consumers Consumers are the mirror image
of the producers in commodities, or almost any
company of medium to large size in the financial
derivatives markets. They may be issuers or investors in securities. Again the aim is to prevent
surprises, or lock in what is seen as a favourable
rate or price of a financial product or security.
Intermediaries These may be banks, brokers
or simply speculative traders. They are likely to
provide up to 90% of the volume in any market,
but their influence on price is less clear and is the
subject of much argument. Their activity provides
essential liquidity but also increases volatility.
They will often have no underlying interest

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whatever in the commodity. However, without

their participation the markets themselves could
not exist. A technical mishap in the North Sea in
the 1980s led to one US bank trading in oil futures becoming the proud owner of a physical
tanker full of crude oil in a falling market, to the
great satisfaction of many oil companies.
1.4

Market Developments

Options, swaps and securitization (the packaging

of financial assets such as car loans into units that
can be traded in blocks as long term bonds) are
the massive changes of the last twenty years in
the financial markets. They have changed the
whole landscape of large scale, especially
corporate, financing. Recent studies report an
increased use of derivatives in the US since the
problems of the early 1990s in which firms such
as Proctor and Gamble lost huge sums of money
using complex derivatives packages. 66% of
middle sized companies in US are using
derivatives more than in 1994. Since 1990 the
outstanding principle value of interest rate swaps
has risen by $725 bn to $11.8 trillion, and FX
swaps by $262 bn to $5.6 trillion.2
Another important development has been the
development of asset backed bond financing. This
was initially driven by a desire to free capital for
further funding. In the UK it was seen in the
Sterling Floating Rate Note market with large
issues by major building societies in the 1980s. In
the United States, where these instruments were
developed by the vehicle finance subsidiaries of
the major automobile manufacturers, almost any
receivable can be packaged and sold in a bond.
However, the technique is now more widely used,
for example in project finance, to break up the
risks in a project, with different lenders or sponsors retaining only certain risks. An example
would be the funding of the Second Severn Crossing in part by an indexed linked bond at
RPI+6%... The structure of the loan meant that the
lenders were taking the risk on traffic flow

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projections more than on the construction of the

new bridge. There is also a proliferation of further forms of derivative, involving not only asset
packaging but the breakdown of risk into smaller
and smaller discrete units. These include the
securitization of credit guarantees, the swapping
of credit risk, economic hedges through a swap of
total return on an investment, and in the insurance market loan issues with an option for the
buyer to sell back to the borrower in the event of
defined catastrophes (a put option). The list
could be extended.
One feature unites these developments: risk. New
financial instruments are driven less by the simple
need to raise finance (although that must be
somewhere in the foundations) than by the desire
to manage risk. At the heart of almost all the
instruments is a more calculated analysis of risk,
and an attempt to divide it more cleverly so that
parties take the risks they want and lay off the
ones that they do not want. In the case of options
or futures this is obviously the very raison dtre
of securitized products. Securitization is often
more the delivery of differentiated risk than asset
packages.

2 RISK MANAGEMENT

In the late 1970s a new Treasurer was often given

a 150 page book written by the then head of
Hambros Foreign Exchange. After reading it he
or she had learned most of what mattered in FX.
The big problems were settlement and dealing
practice. Forwards and forward-forwards were the
height of strategy. Today there are a series of
exams, and lengthy articles in 75% of the issues
of the Treasurer magazine which cover only the
foothills. Complexity grows exponentially. Risk
management is the buzz term in Treasury (always
an empire-building profession), and its practice is
an increasingly black art.
At times one feels that the Treasurers profes-

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sion and the corporate finance sector in the City

are engaged in a mutually rewarding process of
finding ever more complicated ways to manage
the risks that their methods are creating ever
more prolifically. The only simple parts are the
bill at the end and the rise in the Treasurers pay.
All complexity leads to obscurity. The struggle is to seek transparency of risk so that both
management and those innocents who deal with
the corporate entity know who they face. The
importance of this is shown clearly both with
National Westminster Bank and, supremely, with
Barings. The former case has so far led to little
more than embarrassment, the loss of some bonuses, and an effect on the share price. In the
latter case there remain a number of investors
who did not realize the far higher risks they were
running, with or without Leeson. Although he
was the final cause of the fall, Barings
increasing reliance on high levels of dealing in
volatile and complicated products was effectively
changing both its risk profile and its corporate
ethos.
2.1

Should We Try to Manage Risk?

The ethical question with regard to financial risk

has at its core the ethics of risk management, and
the desire for predictability in the future. Risk
management involves looking at the justice of the
distribution of risk rather than only the relative
benefits in a consequentialist manner.3 In general
terms this is obvious in the normal running of
life. I should take normal precautions against
harm provided that they do not lead to harm to
someone less able to protect themselves. It is
ethical to test the strength of ice before walking
on it, but not to do so by putting my children on
it first, on the grounds that their earning power is
less than mine and they are therefore more
expendable.
In retail finance this is seen in 1980s and
1990s legislation on Investor Protection. The
burden of risk in ensuring that a product is suit-

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able for the purchaser has shifted dramatically

from a caveat emptor approach to fall squarely on
the seller. Thus in any sale of life products the
majority of the paperwork is less about the product than whether the purchaser has had all the
legal and prudential warnings. It is recognized
that a life company is in a far better position to
assess risk than an individual, and must make
sure that the investor has had the risk
management carried out on their behalf.
Legislation directs that more weight is given to
an ethical than market driven distribution of risk.
2.2

The Risks of Risk Management

All action to resolve risk creates risk. Yet in

financial markets inaction is in itself the adoption
of a risk profile. As a portfolio manager, to invest
or leave reserves in cash are both risk choices. In
FX, to engage in the use of option strategies creates many risks, not to do so creates others. Even
Boards of Directors have begun to recognize this
as the risks of risk management have loomed
larger in professional thinking.
In response to the Leeson affair, Proctor &
Gamble, Metallgesellschaft, Orange County and
lesser known events, the burden of managing risk
management has grown, to the point where its
consumption of resources in non-financial firms
must begin to pose ethical questions even in
consequentialist terms.4
The Futures and Options Association has
published guidelines for corporates on the use of
derivatives.5 They establish six principles: (i)
The Board produces effective policy for use of
derivatives, (ii) senior management (SM) establish clear written procedures for implementing
the derivatives policy, (iii) creation by SM of an
effective framework of internal controls and audits, (iv) SM establish a sound risk management
function for ... controlling all aspects of risk, (v)
procedures in place for a full analysis of all
credit risks, (vi) procedures for management of
legal risk.6 The document recognizes that de-

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rivatives may be used for hedging, but some

transactions which are thought to be hedging
may only modify the organizations risk exposure,7 for example an interest rate swap. In the
commentary on the principles, (i)-(iv) and especially (iii) and (iv) require considerable use of
management time and energy. The impression
given is of a highly dangerous activity that builds
considerably more risk into the operations of the
company and that will need much senior management time, and staff recruitment, to control.

ETHICAL PERSPECTIVES ON
RISK MANAGEMENT

The question must be asked whether it is ethically

justified to use resources in this way. Risk is
inherent in life; new financial instruments are
often loosely thought of as hedges when they are
risk management tools. There is a responsibility
for managers who use them to recognize the true
nature of what they are doing. Given that most
instruments are copious users of energy and other
intangible resources of the business, as well as
having a risk profile deriving from their use at
all, they must be justifiable in terms of consequence, rule or virtue.
3.1

Justifiable in terms of consequence

No market is morally neutral.8 It both expresses

and needs a moral framework which is wider than
the market itself. This framework can quite properly justify the basic operations of the system.
But because it is a wider moral framework it will
also correct and supplement those operations in
the light of values to which the market itself
appeals.9
This is true, but most ethical discourse in finance is essentially a form of debased utilitarianism or consequentialism. The question we ask
too often is does it have good results?, rather
than is it good? There is a sense in which that

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is right: any ethical conclusion must have a reason, though the reason may become God says
so. But in business ethics the result has become
more and more narrowly defined. One result of
this is seen in the common and fallacious argument that ethical behaviour is good because it
contributes to the bottom line. The moral framework becomes a subsidiary of the market. Looking at the subject of derivatives has brought this
home to me with fresh power. My first thought
was what harm can they do? I used derivatives
for many years, without qualms, as a means of
protecting the interests of the company for which
I worked. They provide a focused, transparent
and efficient method of adjusting price to supply
and demand. In the oil industry they were certainly less damaging in their results than the
cartel of the 1970s, OPEC, with its indifference to
the poorer countries, its corruption and overwhelming greed. At least the derivatives market
in oil seems impersonal. The counterparty is
invisible.
This is a classically utilitarian argument of the
greatest benefit to the greatest number. Similar
arguments are ready to hand in other markets.
Financial derivatives may lower the cost of capital by allocating it more efficiently to those best
able to access it who then pass on some of the
benefit through the swaps market. Currency derivatives may ease the risk of cross-currency
investment. Some benefit in terms of risk management will at least be intended for all users of
derivatives where the use is driven by commercial
considerations other than those of trading in
derivatives. Within the derivatives markets themselves this issue is extreme. It is a truism to say
that a market price cannot be wrong, it is simply
a price. In a futures trading pit no ethics exist
except performing what you have promised.10
Inevitably therefore, our comments are from outside the structure of concepts that many practitioners would consider valid.
The consequences of trading in complicated
and risky instruments may be more subtle than

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accounting can reveal. Risk is not always measurable but at times may be inherent in the ethos of
an organizational system, part of the culture, like
safety. Whatever the controls, a company with a
high risk ethos is likely to run high risks. In the
early 1980s, at the time of the panic caused by
the run on the US bank, Continental Illinois, the
Financial Times commented, Banks should be
boring. The use in financial organizations of
many of the new financial instruments requires
the recruitment of teams whose rewards are usually linked to performance on a profit centre
basis. This in itself creates a high risk ethos
which is a ratchet that progresses inevitably, and
whose culture is often more powerful than all the
controls that can be invented.
Although many new financial instruments may
benefit many companies and people (look at the
example of the new availability of flexible fixed
rate mortgages in the UK, all derivative based),
like nuclear power, the accidents can have
massive fall-out. It is far from clear that the
greatest good of the greatest number is the result
of the unfettered development of new financial
instruments. Even the largest banks seem unable
to prevent losses through rash or unauthorized
dealing: banks may have abandoned the safe role
of the banker in roulette or the bookmaker at the
races in favour of gambling themselves.11
3.2

Justifiable in Terms of Rule

The argument so far is that derivatives have their

uses but also have a great potential for harm.
They concentrate power without accountability.
They distance markets from the reality of the
people producing. They tend to self-deception
about the nature of the world. But they cannot be
banned. Nor should they be. Properly used they
add flexibility and risk management to investment
decisions, and can facilitate wealth creation.
Three controls are suggested: capital adequacy,
trading restriction and open declaration.
There should be strict limits on the amount of

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capital (and hence open positions) that any institution can commit to derivatives. This could
include step ups in capital allocation once a certain size of position had been reached. There
would have to be some concept of concert-party.
The explicit aim should be to make it prohibitively expensive, and obviously unacceptable, for
a small group of traders to run positions that can
control a market. Trading should be restricted so
as to prevent excessive volatility. This has
worked in New York since 1987. After a certain
move, trading must close for a period.
The companies or people who may trade need
close regulation. Any use of derivatives over a de
minimis level should require regulatory approval.
In particular the use of exotics should require
evidence of adequate systems to monitor and
reveal risk, and a level of independent audit.
Finally, companies using derivatives that are
not traders should have to publish a policy, for
example after the statement of accounting basis,
on the use, limits and intention of derivative
involvement.
3.3

Justifiable in Terms of Virtue

3.3.1

Transparency

Both in the secular philosophical and the religious traditions of European thought, transparency is thought of as a virtue. Iago may be clever,
but is nevertheless a villain because of his dissembling. In the Wagnerian cycle one may feel
that Siegfried is a muscle bound idiot, but still a
hero because of his transparency. Candide is
nave, but his transparency is seen by Voltaire as
virtuous. Johns first epistle has the famous exhortation to walk in the light with one another
and with God. King Davids uniqueness is not his
moral uprightness but his honesty and openness
in his walk of faith, expressed most clearly in
Psalm 51. Straightforward dealing is a City virtue
(dictum meum pactum, the motto of the London Stock Exchange, etc.) and is enshrined in

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legislation and regulation.12

The virtue of transparency is not only ethical
but a management aim in order to understand
risk. Its benefits lie behind reforms in accounting,
the break-up of conglomerates, the fashion for
mission statements that control priorities, and
concern over derivatives. We cannot manage
what we cannot see. A recent Accounting Standard Board discussion paper on financial instruments aims for this. The issue is that, whatever
basis [of accounting] is used, it should be unambiguous, universal and simple.13
Transparency is not only for self-preservation,
in that false information leads to false markets,
but applies even when there is no obvious consequential harm, as is often seen in insider trading.
Transparency is a virtue even of consenting adults
in private, as well as in the open market, and its
importance is being reinforced.
Behind much of the underlying unease that
dominates public discussion of new financial
instruments is a concern about transparency. The
FOA guidelines are designed to ensure that there
is at least internal transparency, so that the highest level of management understand the risk
profiles of the company for which they are responsible. All new financial instruments create
fog. Three examples of this can be given:
What do we owe? A company issues a 7
per cent 250 million loan note, with a 25 year
maturity and fixed coupon. Its lenders, its Board,
its shareholders and, were they to think about it,
its employees, its customers and its suppliers
know that provided it can pay the interest of
8.75 million twice a year its obligations are
complete for the foreseeable future. But then the
Treasurer notes that since the issue, interest rates
have risen, and a swap can be taken out to make
this a floating rate obligation at LIBOR - 1%. His
fear of the opportunity loss if long term interest
rates fall encourages him to act. A few years
later, the issuer buys a company in the US, and to
hedge its translation exposure part of the issue is
swapped from floating rate sterling into a mixture

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of floating and fixed rate dollars. The result of

these actions is a totally different risk profile for
the company, and a series of FX, interest rate and
counterparty risks that neither shareholders (nor
probably the Board) will have clearly identified.
The balance sheet will show the Loan Note, with
a complicated and lengthy note about swaps.
What do they earn? An alternative (and
equally true) example would be that of an oil
exploration and production company based in the
UK, with almost all its costs in and almost all
its revenues in US $. It is also mercilessly exposed
to the oil price. Fearing a fall in the price and a
rise in , it enters into a series of options and
forward transactions the sum result of which is to
provide a graded and diminishing participation in
oil price increases, and considerable protection
against falls. The shareholders will not know
about this until the next annual report; the banks
and analysts may only find out by accident. The
Pru and the Pearl think they are investing in well
managed $ oil exposure; the reality is that they
have a temporary utility with more or less fixed
prices. The market is false.
Who am I dealing with? A company enters
into a syndicated loan with 12 banks, contributing
varying amounts totalling US$350 million, in a
multi-currency, multi-option, fully revolving
form. The banks are chosen on the basis of their
significant levels of business with the company,
familiarity with its kind of business, geographical
spread of their activities and credit strength. The
Treasurer of the borrower has a moment of inattention as the lawyers wade through the terminally dull pages on assignment and intra-syndicate obligations. Two years later, at a time when
business is tight and the company struggling, a
routine roll-over produces a shortfall of the Spanish peseta equivalent of US$10 million because
one of the twelve has sold a sub-participation of
the loan to a regional Japanese bank that is having funding problems. In the negotiations which
follow, as the companys liquidity drains away
towards default, the Treasurer finds herself facing

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17 banks, 8 of whom she has never met before,

and with whom there is neither relationship nor
understanding. Different kinds of cases could be
cited for retail mortgages that are then packaged
and securitized, or credit card receivables.
3.3.2

Self-awareness

Another virtue is self-awareness, considered as

such from Aristotle onwards. New financial instruments compel a proper and well balanced
view of the nature of the company and its outlook. They increase corporate self-awareness, and
encourage a willingness to resist the fatalistic approach to the future that diminishes the significance of human free-will.14 Like health and
safety rules, they encourage the management of
risk, and thus focus an organization on its proper
objectives. They encourage a proper balance
between prudence and risk, leading management
to take the risks it should, and transfer others to
those better able to carry them. An oil exploration
and production company may hedge interest rate
and foreign exchange risk, buying certainty in
contrast to the vagaries of the drill-bit.
3.3.3

Between Recklessness and Immobility

An ethics of virtue raises questions when risk

management becomes obsessive, and behaviour
such as cowardice is first held in contempt and
then treated as pathological in extreme cases. It is
recognized that an obsession with risk paralyses
action, and that there is a proper balance between
recklessness and terrified immobility. An honest
living with the fact of risk and its consequences
is seen as a good. This is a view deeply rooted in
all human ethical traditions, and in the European
seen at its most sophisticated in the Stoics.
The same balance is reflected in the JudaeoChristian tradition. Within the Bible there is a
tension between faith in the ultimate goodness of
God in all circumstances15 and an avoidance of
recklessness that tests providence and faith-

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fulness.16 This same tension is reflected in common law in the Anglo-Saxon tradition with the
tests of reasonable care and contributory negligence. The search for a risk free life is seen in
such absurdities as the famous McDonalds coffee
lawsuit in the US, where a jury initially awarded
damages of $2,000,000 (reduced on appeal) to a
woman who was scalded while simultaneously
driving and trying to drink a hot cup of coffee. In
legal ethics such cases are seen as increasingly
indefensible. The opposite extreme is found at the
Pont du Gard, near Nmes, an unrailed and crumbling Roman aqueduct with a vertical drop of
over 100 feet. Anyone can walk across, if they
dare, the only caution being a rusty sign saying
Les vents puissent senlever, perhaps
translatable as gone with the wind!.
If one takes the three main approaches to
ethics, the consequentialist, deontological and
virtue based, it is clear that the last two place risk
management as one sensible preoccupation among
others, without giving it primacy.

C ONCLUSION
The widespread and elaborate use of new financial instruments among corporate entities and
financial institutions requires justification. It faces
the charge of increasing both the level and complexity of risk in the financial system under the
pretext of reducing it. It is a prodigious user of
management resources and IT. It obscures the
integrity of the nature of the non-financial user.
It is not mere academic argument to question
the ethics of certain instruments. Both in the US
and the UK certain forms of financial instrument
are deemed too risky to be used by all and sundry.17 Other forms of instrument may be banned
outright, even though many financial professionals will be perfectly capable of measuring the risk
involved.18 The force of this attack is recognized
in the financial industry. One defence frequently
put forward is similar to that of the National Rifle

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Association in the US about guns. It is the users,

not the product, that are the problem. One misconception is that derivatives are risky instruments that are used for speculation. It is more
accurate to say that derivatives are instruments
that can be used to alter risk profiles.19 The
mere fact of an instrument existing is no reason
to use it. The biggest advocates of exotic options
are bankers. Practising Treasurers spend much
time seeking to distinguish between the fascinating idea which the banks rocket scientist wants
to try, and the derivative that will genuinely
benefit the company. The fact that many of these
instruments are harmful or spurious does not
mean they should be banned, but neither does the
absence of a ban make them ethical.
The ethical question to ask for the non-financial corporation has to do with the proper balance
of courage and prudence. Will this instrument
enable the company to carry out its proper task
with more focus and self-awareness, or is it an
attempt to neutralize the proper risks that we are
paid to take? For financial corporations the inevitable presence of derivatives poses two issues.
First, are they intrinsically valuable or simply so

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complicated that no client could use them and

monitor the new exposures involved? Secondly,
will the active management of our positions created by this activity result in a change in the nature
of our business, and if so, has this been clearly
communicated to the world around?
On reading this again I am once more struck
by a remark made to me by a clergyman long
before I was ordained. What is an ethical Treasurer? One of the major challenges in the field
of financial ethics is the development of an adequate, and clearly communicated, measure of the
intrinsic ethics of finance.
This paper is not arguing that derivatives are
wrong, but that they are powerful, and power
needs monitoring and controlling. The events of
October 1987 are often referred to as the meltdown of the markets. My clear memory is of the
whole executive board of directors standing in
my office gazing in awe at a Topic Screen (showing FTSE prices) as waves of red chased across
the screen. The use of nuclear metaphors was apt.
A system that seemed safe had assumed a life of
its own. There is little doubt that derivatives
fuelled the reaction.

Notes
1. Justin Welby has been Rector of St. Jamess Anglican Church, Southam in Warwickshire, England, a small market town, since 1995. Before that he was assistant minister (curate) in a depressed urban industrial parish in the
Midlands of England from 1992. Before being ordained he worked in the oil industry, first for Elf Aquitaine in
Paris, and then as Group Treasurer of Enterprise Oil in the UK. During that time he had experience of projects
throughout the world, especially in Nigeria and the North Sea. He is a member of the British Association of
Corporate Treasurers, and is still involved in aspects of finance work. He holds degrees from Cambridge and
Durham universities.
2. The Treasurer: Journal of the UK Association of Corporate Treasurers. December 1996, p. 8 ff.
3. Risk in New Dictionary of Christian Ethics. SCM, p. 557, see also The Common Good, Catholic Bishops
Conference 1996, 77, p. 19.
4. Stewart Hodges, Director, Financial Operations Research Centre at the University of Warwick, pointed out, in a
complicated article dealing with the effects of delta hedging using the Black-Scholes model, that the risk exposure
is constantly adjusted in response to market movements and that this leads to very high turnover (thus costs and
transaction risks); in fact the expected level of turnover is proportional to the square root of the number of revisions [of the hedge following market movements], becoming unbounded in the limit. Cf. Current Research on
Derivative Products in Treasurer, November 1991, p. 6 and 9.
5. Managing Derivatives Risk Guidelines for End-Users of Derivatives. Futures and Options Association, December
1995.

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6. Ibid., p. 7-10.
7. Ibid., p. 11.
8. Dr Robert Song, at Cranmer Hall, Durham University, has been very helpful in discussing this.
9. Richard HARRIES, Is There a Gospel for the Rich? Mowbray, 1992, p. 95.
10. The film Trading Places, with Eddie Murphy, is an enjoyable and generally accurate way of

understanding
this.
11. Editorial in Treasurer, April 1995.
12. Stock exchange listing regulations, especially obligations on disclosure of material facts, insider trading legislation and Takeover Panel rules about concert parties, would be three examples.
13. David CREED (Group Treasurer Tate & Lyle PLC), A personal view of the ASBs Financial Instruments Discussion Paper in Treasurer, October 1996, p. 16.
14. The basic argument in an article by Gay EVANS (Chairman International Swaps and Futures Association), The
Great Contradiction in Treasurer, October 1996, p. 30.
15. e.g. Daniel 3:17-18 and Romans 8:28.
16. e.g. Deuteronomy 6:16 and Matthew 4:7.
17. Investing in private placements in the US, and the sophisticated investor test under the FSA.
18. Pyramid selling schemes.
19. Gay EVANS, op. cit.

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