Controls

Derivative activities, by their very nature, cross many boundaries of traditional
financial activity. Therefore the control function must be necessarily broad, covering
all aspects of activity. The primary element of control lies in the organization itself.
Allocation of responsibilities for derivatives activities, with segregation of authority
where appropriate, should be reflected in job descriptions and organization charts.
Authority to commit the institution to transactions is normally defined by level or
position. It is the role of management to ensure that the conduct of activity is
consistent with delegated authority. There is no substitute for internal controls;
however, dealers and end-users should communicate information that clearly indicates
which individuals within the organization have the authority to make commitments.
At the same time, all participants should fully recognize that the legal doctrine
of ‘apparent authority’ may govern the transactions to which individuals within their
organization commit.
Definition of authority within an organization should also address issues of suitability
of use of derivatives. End-users of derivatives transactions are usually institutional
borrowers and investors and as such should possess the capability to
understand and quantify risks inherent in their business. Institutional investors
may also be buyers of structured securities exhibiting features of derivatives. While
the exposures to derivatives will normally be similar to those on institutional balance
sheets, it is possible that in some cases the complexity of such derivatives used
might exceed the ability of an entity to understand fully the associated risks. The
recommendations provide guidelines for management practice and give any firm
considering the appropriate use of derivatives a useful framework for assessing
suitability and developing policy consistent with its over-all risk management and
capital policies. Organizational controls can then be established to ensure activities
are consistent with a firm’s needs and objectives.