GDF's growth and development and the factors that have influenced its borrowing decisions.
Gaz de France (GDF) is a French company that was chartered to produce, transport, distribute, import, and export gas. Although the early 1980s were difficult moments for its growth in that large government budget deficits and trade deficits led to inflation and high interest rates and the Mittterand government refused to allow it to rise its prices, 1985 onwards were better years in that it covered some of its debts and made a profit from turning to international sources through its liability-management program. The French economy, too, with change of government, appeared to be improving; inflation and interest rates were controlled; and industrial gas prices in France were deregulated, allowing FGDF independence and flexibility in its pricing policy.
It was due to the fact that the French franc during these years appreciated against the dollar, although it struggled to keep up with the deutsche mark that likely resulted in GDF's borrowing decisions. Likely, too, its earlier economic difficulties (during the Mitterand years of centralization) also led to this decision. In fact, it was during these self-same years that GDF's substantial borrowing needs caused M.Reboul, its manager to devise his innovative and opportunistic liability management program. The domestic French franc debt market was -- during those difficult Mitterand years -- relatively small and GDF was prohibited from raising its gas prices, so GDF was forced to turn to international markets, which entailed substantial offshore and non-franc borrowings. In this, it was also helped by its national government. By 1985, GDF showed a profit of FF485 million that represented a considerable turnaround from its loss a year ago of FF3, 020 million. Although a combination of elements were involved in its profits, its liability management was obviously paying off. .
2. Risk exposures (financial and operational risks) faced by GDF since 1986; and the ability of GDF to face these risks.
Although during the spring of 1986, the French franc continued to appreciate against the dollar, even reaching a considerately stronger amount than a year ago, at the same time the franc was under pressure relative to the deutsche mark. This situation could result in realignment in the European Monetary System (EMS) that would then substantially affect the cost of GDF's ECU debt. The foreign exchange environment was changing, and even though GDF, through its franc-dollar profits had begun to make accounting provisions for possible losses from some of its swaps - the possible changing fiscal exchange environment would not only potentially impact GDF's debt but would compel it to revise its entire liability-management program and possibly eliminate it altogether.
A further reason for GDF to be concerned was the increasing complexity of managing the risks. GDF's staff were now involved in executing over a hundred transactions per year and this task of monitoring and controlling all these swaps could well topple over the whole edifice and become too overwhelming for the organization to handle. Too many factors were involved in these swaps and too many risks. Despite the computer model used to price swaps, other factors such as credit exposure and liquidity had to be considered too, and the growing complexity of the business, GDF had sunk itself in too many risks.
Finally, the success of the liability-management program had instigated public scrutiny and publicity, much of it critical and adverse. If GDH were ever to realize losses on some of its swap positions, they would have to articulate convincing and demonstrative justifications for their policies and decisions to a great deal of French financial executives even though GDF had money shored up for such risks, there were too many factors involved that necessitated that GDF reconsider the possibility of unwinding its liability management program.
3. GDF's "liability management practice." How swaps enable GDF to manage its liabilities.
Since GDF had substantial debt and substantial borrowing needs which it could not satisfy from its relatively poor domestic French market, it reopened, in 1985, the Euro-French franc market with a FF489 million issue. At the same time, and backed by standby credit facilities in both francs and ECU, it became an active issuer of dollar-denominated commercial paper in the U.S. market.
Its most innovative step came in July 1985, when the GDF altered its capital structure by issuing its 'titres participatifs' (TPs), i.e. perpetual participating bonds that became a popular instrument in the French market. These TPs allowed the investor to share in profits of the enterprise and had no fixed maturity dates.
Since the franc appreciated, sometimes, as much as ten times against the dollar, and since the terms of the swap were such that at initiation the value of the swap was zero, a franc-dollar swap with a fixed $ rate of 6% with franc leg making cash deposits of 96.237 million per year for 4 years would make a final comeback of FF1, 069.30 million at the end of these 4 years. In the event of potential depreciation or loss, GDF could, through its banks that it used to negotiate these swaps, make a "stop loss limit" on the value of the swap at little or no extra cost. This provided GDF an asymmetric liability position since it gave it unlimited gains whilst facilitating its losses. So, for instance, if GDF initiated a swap with the terms listed above and then, after 1 year found that interest rates and exchange rates had changed, making it decided, accordingly, to unwind its original swap it would face the following situation: The dollar flows, being larger, would cancel the swap, therefore the franc cash flows coming in from the reverse swap are now larger than the cash flows going out (since dollar has appreciated to franc). Given that conditions have changed, GDF's gain from unwinding the swap of the situation above would be equal to 553.1 million.
Computer models, devised by GDF, enabled the company to do these calculations quickly and monitor profit or loss for each swap. It was careful with whom it swapped and quotes on the value of unwinding a swap could be obtained directly from market makers.
As a further step, since French francs were not always available, GDF swapped francs into ECUs because, it reckoned that with Economic Monetary Standard constraints, the ECU would not likely substantially appreciate against the franc, and ECU interest rates reflected the low levels available in the Netherlands and Germany. M. Reboul also used currency futures, interbank forwards, and currency option and stressed that although swap activities were designed ass long-term hedges, GDF was not committed to holding swaps for its entire lifetime.
3. Swaps used by GDF. Analysis of how swaps have affected GDF's performance
The swap activities were the crux of the success of GDF's liability -- management program leading to its $143 million profits over the last 3 years (reflecting in the summer of 1986).
Swaps that M. Reboul used included currency and interest-rate swaps, forwards, futures, and options to transform a significant portion of GDF's non-franc debt. Although the French franc-U.S. dollar swap was his most profitable transaction, M. Reboul also used swaps in other currencies such as in the deutsche mark, the Japanese yen, Canadian dollar, and Dutch guilder. Whenever the swap seemed to be unreliable, M. Reboul had built in arrangements with the banks that he used where the bank would commit to unwind automatically GDF's swap if it hit the pre-agreed loss limit in exchange or a cash payment from GDF of this amount.
All of this resulted in GDF's remarkable profit in 1985, of FF485 million which represented a considerable turnaround from the previous year's loss and attracted considerable publicity in France and in the international banking community.
4. Analysis of the success of M.Reboult's liability-management program
Despite M. Reboul's program having its risks as well as its ethical concerns (the swapping unwinding procedures, for instance), everything of value necessitates risk, and, very many times, it takes new thinking to propel a company forward rather than a persistent laboring on its old path. Were M. Reboul to have continued, in 1985, borrowing from a depleted government and disallowed to raise its prices, his company would have likely floundered and become bankrupt. This is specially so since, as Graph 1 shows, France is the smallest producer of natural gas in the world (6 billions of cubic meters) and, therefore, would make little profit at home and cannot compete against the international market in the product. It also, as Exhibit 2, shows, possesses the smallest natural gas reserves in the world.
Keeping itself afloat in the discouraging economic situation of the Mitterand years when official reserves were drained as the balance of payments worsened and when it was not allowed to increase its prices to cover higher costs would take a miracle and a genius of an idea to create this miracle. This is exactly what M. Reboult produced and for which he would deserve a bonus.