The role that derivatives can play in allowing counterparties to manage risks is now widely accepted. Previously, counterparties might simply have borne these risks or elected not to undertake the business that entailed the risks. Derivatives are now seen as an essential tool that market participants have for managing risk. The rhetoric even from banking supervisors and central banks has become more muted of late as they also acknowledge derivatives' role and utilize market developments and models in new supervisory standards. This change in the attitude toward derivatives has occurred in no small part because more and more observers of the market are learning to distinguish between the instrument itself and the way in which that instrument is used by market participants.
Derivatives are a means of shifting risk.
Problems do not arise simply because a party that is better able to bear risk agrees, for a fee, to assume that risk from a party that is less able to bear it. Instead, problems arise if the parties to the agreement do not understand the risks that they are assuming or have inadequate controls for managing that risk. Perspectives on Asia Events in Asia are providing a test of more than just attitudes toward derivatives. Turmoil in these markets also has provided an important test of the risk management processes that OTC derivatives dealers have put in place and the infrastructure supporting those systems. The jury is still out in some respects, but preliminary reports of how U.S. banks have fared provides valuable insights and lessons.