It is often forgotten – or ignored – that derivatives serve a real economic purpose. They help companies manage risk, which creates certainty and stability. That stability gives those companies the confidence to invest, borrow, grow and hire. That contributes to economic growth.
Examples include companies using derivatives to lock in the cost of issuing debt to finance new investments. Exporters using derivatives to create certainty in the exchange rate at which they can convert future overseas revenues. Pension funds using derivatives to protect the value of pensions for future retirees. Food producers using derivatives to hedge crop and livestock prices. And banks and mortgage providers using derivatives to manage the risk from their loan books, enabling them to keep on lending.
In each case, these entities are using derivatives to create certainty. No one can predict how markets will move in future, but being able to lock in a foreign exchange or interest rate that a firm is comfortable with enables that company to better plan for the future. That’s incredibly valuable.
Now, let’s be clear: we think derivatives markets need to be safe and efficient, and the trading of these products needs to be accompanied by sound risk management. That’s why we have supported regulatory efforts since the crisis to improve transparency and mitigate counterparty credit risk. As a result of those measures, the financial system is more resilient than ever before.
But the bottom line is that derivatives continue to be used by a whole range of companies because they’re useful – because they help them manage risk. If they didn’t find them beneficial, they wouldn’t use them.
But don’t just take our word for it. Here are a couple of public statements from regulators in the US and Europe charged with reforming how derivatives are traded.
“[L]et us again be reminded of the essential role of global derivatives markets: to help moderate price, supply and other commercial risks – shifting risk to those who can best bear it from those who cannot. Thus, well-functioning global derivatives markets free up capital for business lending and investment necessary for economic growth – economic growth that still remains far too meager on both sides of the Atlantic.”
“Most Americans do not participate directly in the derivatives markets. Yet these markets profoundly affect the prices we all pay for food, energy, and most other goods and services. They enable farmers to lock in a price for their crops, utility companies and airlines to hedge the costs of fuel, exporters to manage fluctuations in foreign currencies, and businesses of all types to lock-in their borrowing costs. In the simplest terms, derivatives help businesses throughout the US economy manage risk.”
“Derivatives are a key part of our financial markets and account for hundreds of trillions of euros in volume. Under the right conditions, they contribute to financial stability, by allowing market participants to redistribute risk among each other. For example, they allow exporters to fix their prices despite fluctuating exchange rates, and banks to offer fixed-rate mortgages even as interest rates move.”
And here’s just one public statement from an association representing derivatives end users. There are plenty more out there in the public domain.
“The use of derivatives to hedge commercial risk has key economic benefits. It allows businesses – from manufacturing to healthcare to agriculture to energy to technology – to improve their planning and forecasting, manage unforeseen and uncontrollable events, offer more stable prices to consumers and contribute to economic growth.”