Goldman Sachs 2004 Annual Report Download - page 37

GOLDMAN฀SAC H S ฀ 2004฀ A N N U A L ฀ R E P ORT ฀ ฀ ฀ 3 5
management’s฀discussion฀and฀analysis
management’s฀discussion฀and฀analysis
GOLDMAN฀SAC H S ฀ 2004฀ A N N U A L ฀ R E P ORT ฀ ฀ ฀ 3 5
reduce the fees we earn for managing assets. Even in the
absence of uncertain or unfavorable economic or market
conditions, investment performance by our asset manage-
ment business below the performance of benchmarks or
competitors could result in a decline in assets under manage-
ment and, therefore, in the incentive and management fees we
receive.
•฀Concentration of risk increases the potential for significant
losses in our market-making, proprietary trading, block
trading, merchant banking, underwriting and lending busi-
nesses. This risk may increase to the extent we expand our
proprietary trading businesses or commit capital to facili-
tate primarily client-driven business. For example, large
blocks of stock are increasingly being sold in block trades
rather than on a marketed basis, which increases the risk
Goldman Sachs may be unable to resell the purchased secu-
rities at favorable prices. Moreover, because of concentra-
tion of risk, we may suffer losses even when economic and
market conditions are generally favorable for others in the
industry. We also regularly enter into large transactions
as part of our trading businesses. The number and size of
such transactions may affect our results of operations in a
given period.
•฀The volume of transactions that we execute for our cus-
tomers and as a specialist may decline, which would reduce
the revenues we receive from commissions and spreads. In
our specialist businesses, we are obligated by stock
exchange rules to maintain an orderly market, including by
purchasing shares in a declining market. This may result in
trading losses and an increased need for liquidity. Weakness
in global equity markets and the trading of securities in
multiple markets and on multiple exchanges could adversely
impact our trading businesses and impair the value of our
goodwill and identifiable intangible assets. For a further
discussion of our goodwill and identifiable intangible
assets, see “— Critical Accounting Policies — Goodwill and
Identifiable Intangible Assets” included below.
•฀If any of the variety of instruments, processes and strate-
gies we utilize to manage our exposure to various types of
risk are not effective, we may incur losses. Our risk man-
agement strategies and techniques may not be fully effec-
tive in mitigating our risk exposure in all market
environments or against all types of risk.
c r e d i t฀ r i sk ฀– ฀We are exposed to the risk that third parties
that owe us money, securities or other assets will not perform
their obligations. These parties may default on their obliga-
tions to us due to bankruptcy, lack of liquidity, operational
failure or other reasons. We are also subject to the risk that
our rights against third parties may not be enforceable in all
circumstances. The amount and duration of our credit expo-
sures have been increasing over the past several years, as has
the breadth of the entities to which we have credit exposure.
As a clearing member firm, we finance our customer positions
and we could be held responsible for the defaults or miscon-
duct of our customers. In addition, we have experienced, due
to competitive factors, pressure to extend credit and price
more aggressively the credit risks we take. In particular, cor-
porate clients sometimes seek to require credit commitments
from us in connection with investment banking and other
assignments. Although we regularly review credit exposures to
specific clients and counterparties and to specific industries,
countries and regions that we believe may present credit con-
cerns, default risk may arise from events or circumstances that
are difficult to detect or foresee. In addition, concerns about,
or a default by, one institution could lead to significant liquid-
ity problems, losses or defaults by other institutions, which in
turn could adversely affect Goldman Sachs.
liquidit y ฀ri s k ฀–฀Liquidity is essential to our businesses. Our
liquidity could be impaired by an inability to access secured
and/or unsecured debt markets, an inability to access funds
from our subsidiaries or an inability to sell assets. This situation
may arise due to circumstances that we may be unable to con-
trol, such as a general market disruption or an operational
problem that affects third parties or us. Further, our ability to
sell assets may be impaired if other market participants are seek-
ing to sell similar assets at the same time.
Our credit ratings are important to our liquidity. A reduction in
our credit ratings could adversely affect our liquidity and com-
petitive position, increase our borrowing costs, limit our access
to the capital markets or trigger our obligations under certain
bilateral provisions in some of our trading and collateralized
financing contracts. Under such provisions, counterparties
could be permitted to terminate contracts with Goldman Sachs
or require us to post additional collateral. Termination of our
trading and collateralized financing contracts could cause us to
sustain losses and impair our liquidity by requiring us to find
other sources of financing or to make significant cash payments
or securities movements. For a discussion of the potential
impact on Goldman Sachs of a reduction in our credit ratings,
see “— Capital and Funding — Credit Ratings” included below.
o p e r a t i o n a l ฀ r i s k฀–฀Our businesses are highly dependent
on our ability to process, on a daily basis, a large number of
transactions across numerous and diverse markets in many
currencies, and the transactions we process have become
increasingly complex. Shortcomings or failures in our internal
processes, people or systems could lead to, among other con-
sequences, financial loss and reputational damage. In addi-
tion, despite the contingency plans we have in place, our
ability to conduct business may be adversely impacted by a
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