For
Immediate Release Wednesday, April 17, 2002
For More
Information, Please Contact:
Stacy Carey, ISDA
New York, (212) 332-1200; Fax (212) 332-1212; scarey@isda.org
49 30 2602, ext.
4126, jennifer@kennedycom.com
ISDA ISSUES ENRON REPORT
Corporate Governance Failures, Not
Derivatives, Led to Enron Collapse
BERLIN,
GERMANY, Wednesday, April 17, 2002 – At its
17th Annual General Meeting today in Berlin, the International Swaps
and Derivatives Association (ISDA) issued “Enron: Corporate Failure, Market Success”, a report
examining the failure of Enron.
In the report, ISDA analyzes the role of derivatives
at Enron and concludes that they were not a factor in the firm’s collapse. Rather, that collapse was due to Enron’s
well-documented failures in corporate governance.
The report also articulates that as a major
participant in energy and energy derivatives trading, Enron tried to evade
market discipline by inflating its creditworthiness. These efforts were ultimately unsuccessful due
to the powerful and protective forces brought to bear on any participant in the
swaps business. Finally, the report
states that this market discipline and the legal certainty afforded to swaps
ensured the smooth functioning of the derivatives business in the aftermath of
Enron’s collapse.
Commenting on the report, Christopher L. Culp,
Ph.D., a noted derivatives expert said, “As the report notes, market forces
impose a powerful discipline on swaps activity and swaps participants, as well as
a powerful sanction on those who try to evade this discipline. This, combined with the continued, smooth
functioning of the derivatives business – even amidst the Enron turmoil – would
seem to confirm the argument that no additional regulation is required.” Dr. Culp is Managing Director of CP Risk
Management, LLP, and Adjunct Associate Professor Finance, Graduate
The report refutes calls for greater derivatives
regulation and argues that existing corporate governance, market discipline and
legal certainty adequately safeguard the stability of the financial
system. Moreover, the report warns that
additional government regulation could create instability by increasing moral
hazard and decreasing legal certainty.
Highlights from the report’s analysis include:
q Corporate Governance: The Enron failure demonstrated a failure of corporate governance, in which internal control mechanisms were short-circuited by conflicts of interest that enriched certain managers at the expense of the shareholders. Although derivatives made appearances in the course of Enron’s governance failures, this report concludes that OTC derivatives did not contribute to Enron’s collapse.
q Market Discipline: Enron’s actions appear to have been undertaken to
mislead the market by creating the appearance of greater creditworthiness and
financial stability than was in fact the case, and the
market in the end exercised the ultimate sanction over the firm. The report notes that even after Enron
failed, the market for swaps and other derivatives worked as expected and
experienced no apparent disruption.
There is no evidence that the market failed to function in the Enron
episode. On the contrary, the report
found that the market did exactly what it is supposed to, which is to use
reputation as a means of monitoring market participants.
q Legal Certainty: An integral part of the swaps framework, legal
certainty refers to the expectation that property rights and contracts will be
recognized and enforceable within a jurisdiction. As noted in the report, the legal certainty
achieved in the Commodities Futures Modernization Act passed in 2000
contributed to the orderly unwinding of swap transactions following the Enron
collapse. Enron had approximately 800
contracts outstanding involving a notional amount of over $8 billion, yet there
were no disputes or litigation associated with the closeouts and no apparent
settlement problems.
q Increased Government
Regulation: The report argues that there
is no evidence that existing regulation is inadequate to solve the problems
that did occur. Had Enron complied with
existing market practices, not to mention existing accounting and disclosure
requirements, it could not have built the “house of cards” that eventually led
to its downfall. Finally, the report
suggests that additional government regulation, by increasing moral hazard and
decreasing legal certainty, could have the unintended consequence of making
future failures and market instability more likely, along with increasing the
cost and decreasing the availability of risk management tools like swaps.
The complete report, including a detailed
examination of Enron’s Special Purpose Entities (SPEs)
can be found at www.isda.org.