Procter & Gamble’s Tale of Derivatives Woe – The New York Times

| September 4, 2019

Procter & Gamble’s Tale of Derivatives Woe – The New York Times… This copy is for your personal, noncommercial use only. You can order presentation-ready copies for distribution to your colleagues, clients or customers, please click here or use the “Reprints” tool that appears next to any article. Visit for samples and additional information. Order a reprint of this article now. » April 14, 1994 Procter & Gamble’s Tale of Derivatives Woe By Lawrence Malkin NEW YORK— What is a soap company doing in the swap market speculating with hundreds of millions of dollars? The cautionary tale of the Procter & Gamble Co., which lost $157 million when interest rates turned against it, is not the first nor probably the last that will emerge from the great shakeout of 1994. Like most multinational companies, Procter & Gamble had been protecting itself against swings in international interest and currency rates for years by plain vanilla swaps of fixed for floating-rate debt or vice- versa and occasional use of options, futures, and currency trades to hedge the company’s bets. Wrong guesses meant small losses, usually balanced by small gains when the company was right, which was the object of the whole exercise. Late Tuesday, Edwin L. Artzt, the chairman of Procter & Gamble, disclosed that liquidating two contracts for interest rate swaps cost the company $157 million, $102 million of which would be charged, after tax, against third-quarter profit. Although not catastrophic for a $30 billion company like P&G, it was one of the largest ever suffered by an American company – although small when compared with the $1.36 billion lost by Germany’s Metallgesellschaft AG in oil futures trading last year. “Derivatives like these are dangerous and we were badly burned,” Mr. Artzt said. “We won’t let that happen again.” The swaps were based on borrowed money, which exaggerated market swings tremendously and meant big money if P&G was right – as it had been on some previous derivative deals. But the two losing contracts, which were for floating-rate notes in dollars and Deutsche marks, were written through Bankers Trust Co. on the assumption that U.S. and German interest rates would continue to fall. That bet turned sour after Alan Greenspan, chairman of the Federal Reserve Board, announced on Feb. 4 that the central bank was raising short-term rates for the first time in five years. But for months before that, Wall Street had been alive with talk that the Fed would change course. It was only a question of when not whether, and anyone gambling heavily on a continued fall in rates was riding for some kind of fall, as even high-risk hedge fund managers like George Soros discovered in February when they lost hundreds of millions. 1 of 2 12/6/2017, 6:09 PM Procter & Gamble’s Tale of Derivatives Woe – The New York Times… As Mr. Soros himself conceded Wednesday in Congressional testimony on derivatives, “the risks involved are not always fully understood even by sophisticated investors, and I am one of them.” Geoffrey Bell, who runs his own investment company and is executive secretary of the Group of Thirty, an academic and financial study group, said “P&G’s business is toothpaste, not highly leveraged swaps. It’s one thing to hedge, but why were they leveraging up on such a scale? Hundreds of millions more must have been at risk. How could the chief financial officer not know about something that size?” Erik G. Nelson, P&G’s chief financial officer, told analysts that P&G policy was to deal in “plain vanillatype swaps,” and as interest rates rose in February “we started to realize there was an exposure that those involved hadn’t spotted prior to that.” P&G pinned the corporate responsibility on its treasurer, Raymond D. Mains, who has since been sent on “special assignment.” Mr. Artzt also pointed a finger at Bankers Trust and said P&G was considering legal action against the company. But Bankers Trust said senior P&G managers had rejected its recommendation to unwind the swaps weeks ago. A P&G spokeswoman was unable to say why Mr. Nelson was not taking any of the blame. She stressed that the transaction was “speculative and goes outside the P&G policy of conservatively managing our debt portfolio.” Asked whether the company’s treasury was expected to be a profit center. So it would appear that Bankers Trust wrote a complex and speculative contract, the implications of which went beyond the comprehension of P&G’s financial officials at their headquarters far from Wall Street in Cincinnati, and they asked no uncomfortable questions as long as the market was going up and they were making money. More shoes probably will drop. “I don’t expect they’ll be the only company to be hit like this,” one New York banker said. Indeed, Bankers Trust itself, trading aggressively on its own account, lost millions in the same market turn but understood the risks. The lesson for those who don’t has long been clear. In a speech in December, William J. McDonough, president of the Federal Reserve Bank of New York, warned that top managements of financial and nonfinancial companies have a responsibility to understand and constantly monitor derivative markets when their companies are involved in them. “People of my generation who are not astrophysicists have to strain to understand these products,” Mr. McDonough said. “To put it simply and directly, if the bosses do not or cannot understand both the risks and the rewards in their products, their firm should not be in the business.” Copyright 2017 The New York Times Company Back to Top 2 of 2 Home Privacy Policy Search Corrections XML Help Contact Us 12/6/2017, 6:09 PM …
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