Portuguese Train Companies Can’t Escape Snowballs
A customer has some risk that keeps her up at night, she goes to an investment bank, and the bank writes her a contract that takes away her risk in exchange for a nice fee.
But you can’t just make risk disappear. Once the investment bank has taken the risk, where does it go? To the bank’s creditors? To its depositors? To the taxpayers? That isn’t ideal. The best answer, from the bank’s perspective, is often to find another customer to pass the risk along to. Sometimes this works out neatly, because a risk for one customer is a windfall for another, so you can get them to sell each other their risks. (This is the standard story of airlines and oil companies hedging oil prices with each other.) Sometimes you can find customers who just like risk and want to take more of it: Aggressive hedge funds, say, or pension funds with long-term outlooks, might be quite cheerful bearers of various kinds of risk, and if a bank can pipe risks from worried corporate clients to eager hedge funds, it can make money while making the world a better place.
.. The transport companies argue, in essence, that they shouldn’t have been allowed to do that: that it is illegitimate for companies, or at least Portuguese public transport companies, to get paid to take risk off of banks’ hands.
.. The companies argued that Santander should have avoided “conflicts of interest” and given “preference to clients’ interests” over its own. This argument sounds nice, but it cannot be right; it’s a complete misreading of what derivatives trades are. The companies weren’t clients; they were counterparties, and the whole transaction was, in its essence, a conflict of interest.