Most of the concern with derivatives derives only from the fact that “derivatives” sounds so deliciously sophisticated.

Sir, Tracy Alloway and Michael Mackenzie when reporting on the “Dangers to system from derivatives´ new boom", August 20, might not understand the most important differences between underlying markets and the derivatives traded based on these.

In a derivative, there is a buyer and a seller, and so whatever happens someone wins and someone loses and in essence it’s a wash out… of course as long as all can live up to their commitments.

But, in a real market loss, like that of a lower value of a stock, a lower value of a painting, or a lower value of a real estate, there is at that time only a loser… and no winner… that is unless you count he who might have way back earlier sold the stock.

And in this respect the trading in derivatives will depress much less the market than a depression of the values of the underlying vanilla assets.

The big fuss that is raised around the issue of trading of derivatives, again, besides the possibility of one side of the trade not living up to his commitments, has much more to do with the fact that “derivatives” sounds so deliciously sophisticated.

Do not undercut in any way the disciplinarian role of the market

Sir as an Executive Director at the World Bank 2002-2004 and as member of its Audit Committee I remember as one of my biggest frustrations continuously warning about counterparty risks and always ending up being answered along the lines of... “What counterparty risks? Don’t you know that a triple-A is a triple-A is a triple-A?”

This is why I take strong exception when Matthew Richardson and Nouriel Roubini in “Insolvent banks should feel market discipline”, May 7, though correctly advocating more of Schumpeterian creative destruction, are surprisingly lenient in the case of counterparty risk. They even write “But unlike with Lehman, the government can stand behind any counterparty transaction”. No!

What is counterparty risk? The risk that for example the insurance company you have insured yourself with cannot pay up when it should. This risk is clearly not a risk that an ordinary citizen should have to bear but for the financial system’s overall health it is an absolute must that all the qualified institutional participants bear with the full consequences of it.

In fact, in case they have not read it, current third pillar of the otherwise so discredited bank regulations from Basel – named the market discipline, “aims to encourage market discipline by developing a set of disclosure requirements which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposures, risk assessment processes, and hence the capital adequacy of the institution.” And that of course means the evaluation and the taking of counterparty risks.

And by the way, just as the markets would benefit from more creative destruction, let me also remind you that so would our financial regulators

FT should not lend support to the sophisticaters!

Sir in “The start of the great unwinding” January 26 you say “Complexity also adds to the dangers that any part of the hyper-financial system can bring down the whole” and you are right. Nonetheless, you follow it up by saying “Monoline insurers exemplify this kind of reef under the water” and this is clearly wrong; since having some undercapitalized insurers selling coverage while their good fortune last has nothing to do with complexity.

Many of us warned repeatedly about the counter-party risks with agents such as the monoline insurers and the reason it was hard to get that message heard was that it was so easy for them to find in their sleeves the sophistications that confused the issues and killed the debates. FT should not help the market to hide within the complexity in order to hide the simplicity, and perhaps a non-Davos retreat to reflect on what are the simple and time-honoured truths that lie behind the current turmoil could be a good place for you to start.

We need some new derivatives!

Sir, Paul J Davies reports that Moody’s warns on change of control clause”, April 26, with respect to a clause that is supposed to protect the investor from the risk that a company suddenly gets swallowed up in a highly leveraged takeover and leaves him with a much riskier investment that he had originally intended. As it seems some of these clauses when the credit rating agencies downgrade the company but, if the credit rating agency did, as it should, downgrade the company before the formalization of the takeover event then, as no further downgrading should be necessary, the investors could be left out in the cold. As I read it, this seems to be just another example of a derivative market that needs to be developed in order to cover the changes in credit rating methodology and timing of announcements applied by the credit rating agencies. And, after that, perhaps the only remaining risk we need to cover before we can sleep calm under our blissful protective cover, is the regulator risk but, come to think of it, there might not be pockets deep enough to guarantee the counterpart risk on that.

Market risks and counter-party risks, they all live in the same world.

Sir Mr. Greenspan recently reminded the participants in the derivatives markets that the counter-party risks are still linked to the market risks, one way or another, which is true, whether you wish to ignore it or not. As we all operating more and more in one single world market it behoove us to remember that if you insure your office property against fire with an insurance company that happens to own the building where your office is located, then, if fire breaks out, your insurer might be in much worse shape than you.