The Hindu Business Line : Coming clean on contracts

The spate of announcements in recent times from listed corporate entities on the losses suffered by them in derivative contracts across foreign exchange, commodity and credit markets is a measure of the level of integration of the Indian economy with the rest of the world as losses, whether on adverse currency movements or commodity prices, are driven principally by global developments. No doubt, domestic companies have long traded in such instruments. But public disclosure of the adverse consequences of such contracts is a relatively new phenomenon. It came to light when Mumbai-based software company Hexaware announced last November that it had suffered losses on some foreign exchange derivative contracts. Then came the announcement from ICICI Bank that there were losses on its overseas investments in credit derivatives and, more recently, by L&T that its West Asian subsidiary had incurred losses on commodity derivative contracts.

Companies have, of course, put a gloss on such developments with claims such as that they were indulged in by rogue employees or that they are only to be expected in the businesses they are engaged in, or that there was some indirect benefit to the company as the adverse movement in the derivative contract also meant cheaper prices for raw materials used in its production process, and so on. By and large, these events have perhaps only dented the companies’ reputation for possessing astute managerial talent rather than affect their bottom-lines, with the possible exception of Hexaware, whose losses in forex contracts virtually wiped out its profits in the first three quarters of the current fiscal. But, given their volatile nature, any movement in asset prices adverse to the direction assumed in the contract could quickly translate into significant losses as events elsewhere have demonstrated, starting from the spectacular collapse of the UK-based investment firm Barings in the 1990s to, more recently, that of Societe Generale in France.

While companies ought to have the unfettered right to enter into such contracts, even beyond hedging underlying risks in their operations, there is need for a more elaborate disclosure on the company’s policy with regard to entering into derivative contracts. The audit committee of the board should ensure that that the kind of exposure that a company desires is the outcome of deep reflection rather than one occasioned by a top management whim. If, despite sound control systems, losses materialise, a transparent account by the management of the events leading up to the loss would do more to reassure investors that their interests are safe rather than a smoke-screen of obfuscation in the false belief that investors are better off with scanty knowledge.

Related Stories:
ICICI Bank takes $264-m hit on overseas credit exposure
L&T takes Rs 200-crore hit in metals hedging
Hexaware Tech suspects fraudulent currency deals

More Stories on : Editorial | Derivatives Markets | ICICI Bank Ltd

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