EU derivatives plans focus on clearing

July 1, 2009

 Charlie McCreevy    By Huw Jones
   LONDON, July 1 (Reuters) – Centrally clearing the bulk of off-exchange derivatives contracts will be the core of Europe’s efforts to cut risk in the sector as further study is needed before forcing any trades onto exchanges, an EU document said.
   The document is a draft of the EU executive European Commission’s plans to make the over-the-counter derivatives market safer after the credit crunch rang regulatory alarms.
   OTC contracts range from credit default swaps (CDS) to interest rate, equity-linked and commodity contracts. The G20 group of industrialised and emerging countries agreed in April that CDS transactions should be centrally cleared.
   The collapse of investment bank Lehman Brothers and troubles at insurer AIG <AIG.N> and Bear Stearns bank showed regulators how little they knew about the $600 trillion sector.
   “The opaqueness of the market prevented, on the one hand, other market participants from knowing exactly what the exposures of their counterparties were to these three entities, which resulted in mistrust and in the sudden drying up of liquidity,” the document obtained by Reuters said.
   The document has proved contentious and been subject to rewrites.
   EU Internal Market Commissioner, Charlie McCreevy, had planned to publish to document this week but a Commission source said it has been put off to an unspecified date.
   The document says standardisation of contracts — a process already underway — is a prerequisite for central clearing, as well as setting up a central data depositories.
   The plans will be a relief to dealers as they stop short of more radical steps envisaged by the United States which seek to go beyond centrally clearing OTC trades to shift trading onto exchanges or trading platforms where possible.
   The Commission document stresses the need for clearing to take place within the EU so that supervisors have “undisputed and unfettered access to the information held by CCPs (central counterparties).”
   American dealers want to use one clearing house in the United States for all their global trades to cut costs.
   As not all OTC trades can be cleared, the Commission will work to strengthen counterparty risk management in bilateral trades, the document said.
   The Commission wants clearing to become “the norm for OTC derivatives markets as a whole, wherever possible”, the document said, moving beyond just CDS as agreed at G20 level.
   
   STICK AND CARROT
   Dealers have agreed to clear their European CDS transactions in the EU by July 31 and the document says if this deadline is not observed, mandatory actions may follow.
   The EU executive is looking how to significantly strengthen incentives to clear trades so as to “dismantle any commercial hesitation to take up CCP clearing wherever possible”.
   This could be done by slapping extra capital charges on dealers that don’t clear trades and possible legislation to assure that clearers are “safe and sound”, the document said.
   “Naturally, this further work does not in any way affect the deadline associated with the ongoing efforts to move clearing of European CDS onto one or more European CCPs, that is, 31 July 2009,” the document said.
    U.S. Treasury Secretary Timothy Geithner alarmed the industry by insisting on shifting as much trading as possible to exchanges or platforms, making it harder to justify fat margins.
   The bulk of OTC derivatives trading is handled in New York and London so the future shape of the industry could hinge on whether the EU goes as far as the United States.
   Dealers say the EU would benefit from a less strict regime as it would likely attract U.S. business.
   The document, which could be subject to last minute changes, shows that McCreevy is leaving the trading option open for now.
   “In this respect the Commission will further assess the pros and cons of channelling of further trade flow through transparent and efficient trading venues and the appropriate level of transparency — price, transaction, position — for the variety of derivative markets trading venues,” it said.
   A European central data repository — widely referred to in the industry as a warehouse for “golden copies” of trades — should be looked at, the document added.
   The Commission will hold a public hearing on Sept. 25 to discuss the policy proposals, the document said.

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