Derivative formula: Dutch plan ban on pure speculation

Source: E.K Park

It’s a jungle out there: VU is most exposed to ‘open positions’ on its derivatives portfolio and ministers are concerned about losses

The Dutch education minister has proposed a ban on a type of financial derivative used by universities after a report found that it could leave the sector exposed.

Similarly to homeowners on fixed-rate mortgages, Dutch universities use derivatives as insurance against interest rate fluctuations on the money they have borrowed or, more controversially, intend to borrow.

But current low interest rates in response to the global economic crisis mean that the total negative value of derivatives in Dutch higher education amounts to €216 million (£160.6 million), according to a report from the Dutch Inspectorate of Education that was published in November.

Normally, even a sum that large does not translate into institutional losses, provided the derivatives are fully linked to existing loans.

But Leiden University, Wageningen University, VU University Amsterdam and several other institutions have purchased so-called “open positions”: derivatives on loans they expect to take out in the future.

The losses can be massive when institutions are forced to sell their derivatives. Dutch education conglomerate Amarantis suffered a €7 million loss when it was disbanded in summer 2012 and had to get rid of its open positions.

With a negative value on derivatives of €80 million, VU has the largest amount of open positions on its books.

But Ton Ruhe, its finance director, said: “People forget that we will only have to pay that sum if we get rid of these derivatives. And we don’t intend to get rid of them.”

VU purchased its derivatives between 2002 and 2007 when it expected to invest around €1 billion in building projects. At the time interest rates were decreasing, so setting them at 5 per cent seemed sensible.

“One could not foresee then that rates would drop still further,” Mr Ruhe said. However, he added that he was not worried. “Our derivatives run to 2032. Interest rates could well rise above 5 per cent.”

The building projects did suffer “some delays” owing to cuts in government funding and the financial crisis, Mr Ruhe added, “but we are now back on track. The board has approved the first buildings. We have almost concluded negotiations about loans and expect to sign the first contracts soon. I understand the nervousness, but I can now prove that we will be using the derivatives shortly.”

He added: “In retrospect you can say it wasn’t a wise decision, but it’s always easy to judge with hindsight.”

Public risk

Dutch politicians do seem to be nervous about the situation in higher education in light of mishaps involving public money and derivatives. Last year, housing corporation Vestia had to be bailed out owing to the way its €10 billion derivatives portfolio had been handled.

“That money has evaporated,” said Michel Rog, a spokesperson on education for the opposition Christian Democratic Party.

Jet Bussemaker, the Dutch minister for education, culture and science, said that derivatives were a legitimate tool if used “responsibly” by linking them to loans but she plans to ban open positions.

“Institutions can still use derivatives to protect themselves against interest-rate fluctuations but I am banning speculation with public money,” she said.

She has also proposed guidelines to increase knowledge about financial products among education boards and called on the banks to tread carefully when dealing with the sector.

“They should not treat educational institutions as commercial parties, but have a duty to handle them as a special category,” she said.

Jasper van Dijk, education spokesman for the opposition Socialist Party, said the move was a “step in the right direction” but argued that schools and universities should focus on education rather than building projects and loans.

“The collapse of Amarantis shows what happens when institutes lose sight of education. Money went to chauffeured cars and prestigious building projects, anywhere but the classroom,” he said.

His proposal is to reverse the deregulation of building projects. “Decisions…should be removed from boards and returned to central government,” he said.

But Ms Bussemaker, herself a former University of Amsterdam board member, rejected the proposal.

“Buildings and classrooms are part of the core business of educational institutions. If we centralise construction, a government committee will end up deciding on corridor width and classroom sizes,” she said.

Liberal party D66 says that improving institutional democracy would offer a way forward.

“Students and teachers have an interest in improving education, and will act as a counterweight to irresponsible decisions on financing and construction,” a party spokesman said.