Financial Engineering and Financial Policy

Louvre Palace and Pei pyramid. Photo Credit. Wikimedia Commons
Louvre Palace and Pei pyramid. Photo Credit: Wikimedia Commons

Engineering is the activity of applying scientific knowledge to the design, building and control of machines, roads, buildings, electrical equipment, and so on. Financial engineering is about the application of the scientific economic knowledge to the design of the working financial procedures of an organization. Engineering always is searching for the improvement of the effectiveness and the efficiency of the organization. We can talk about financial engineering if we are considering the financial activity as a system that we want to control and improve from scientific knowledge.

Financial engineering has not a real negative component. Engineering is not the first step in a design process. The first step is the definition of the requirements for the system to be built. In the case of product engineering, this initial phase is related to marketing instead of engineering. Marketing defines the main characteristics that the product must have, usually got from some kind of market research. If the final product does not fit people needs or preferences, we would never search for the guilty at the engineering department but at the marketing one.

Although the main characteristics of the product can proceed from people preferences there are other restrictions to the design that can be far from people demand. For instance, there can be political restrictions that will define the requirements of the product like political environmental restrictions. If the engineering department is designing a car and there is a law that limits the emission of gases to the atmosphere, this must be included as a design restriction for the engineering process.

With the design requirements established, engineering process is not totally free. Engineers cannot select any design; there are other restrictions that must be taken into account at the design phase that are related to the policies of the company. For instance, there can be policies related to supplies that limits the providers of components that engineers can select for their designs, and the quality policies can establish a rigorous process for selection suppliers. These policies are an important restriction for the engineering design.

We usually name financial engineering at process of building of an organizational system to reduce the cost of financial support and taxes. How this system is built will depend on the policies of the company. A company with policies of corporate social responsibility can have a lot of restrictions for the construction of this kind of system because it usually has a compromise with transparency while corporation without social responsibility will have fewer restrictions, usually related to comply with legal requirements only.

If the problem is always related to policies of the organization, why has financial engineering got a bad press? There are two main reasons. The most important one is related to complexity. As the complexity a system increases, it is more difficult to analyze it and to understand how it is working, even for its own designers. A complex system hides the way of working of the system in a natural way. In a world demanding more transparency, complexity can provide a way to avoid it. Not engineered systems usually have less structure and are easily analyzed. They are naturally more transparent.

The second reason for the bad press of financial engineering is related to who is controlling the corporate communication. A way to pass any responsibility to other department if there is a discrepancy between the communicated policies and the applied ones is to point the finger on the financial engineering, that can be farther from corporate communication than corporate quality or the legal department.

A financial engineering design can be totally transparent if the senior directorate established that issue as a requirement through its corporate policies and there is a real compromise with transparency and corporate social responsibility that have been verified by an audit of an external and expert professional organization periodically. Financial department must contribute to efficiency of the business, and it can take advantage of all the economic knowledge to improve the results of the company. Financial engineering should be a must for all large organizations, working, of course, under the proper policies to provide the required transparency to the financial markets instead of creating artificial complexity to hide the discrepancy between the communicated and applied policies.


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