EU unveils plan to clamp down on derivatives trading

October 20, 2009

A woman walks past a branch of French savings bank Caisse d'Epargne in Bouvigal, near Paris, October 17, 2008. Caisse d'Epargne merged with Banque Populaire to become the country's second-largest retail bank, said last year it had made a 600-million-euro ($808.1 million) trading loss on share derivatives. (File Photo) REUTERS/Benoit Tessier (FRANCE) By John O’Donnell
BRUSSELS, Oct 20 (Reuters) – The European Commission unveiled plans on Tuesday to drive more trading in derivatives onto exchanges and under the gaze of regulators, publishing a raft of proposed new rules.

Many blame this secretive but lucrative market for helping cause the worst economic crisis since the 1930s. The European Union’s executive arm now wants to impose tougher rules on such business to try to herd trading under the watch of supervisors.

A big part of the market is banks betting on interest rates or the price of commodities and stocks.

But industry uses derivatives too. A European carmaker selling in the United States, for example, would use derivatives to counterbalance swings in the value of the dollar.

In its proposals, the Commission outlines a battleplan to drive more of the $500 trillion-plus market towards central counterparty clearing by penalising those who trade without such a middleman.

When trading is cleared through a central counterparty, which could be run by a bank or exchange, it is easier for supervisors to see what is happening and spot problems.

Such clearing houses also collect money for trades,
which is used to cover a default.

In its text, EU officials outline plans for laws on:
* Ensuring central counterparty clearers (CCPs) do not have low-risk management standards
* Giving legal protection to the customers of CCPs as an incentive to use them
* Putting a supervisor in charge of watching the market

Other highlights include:
* The Commission wants financial firms to keep more security to cover exposure to derivative trading, with officials warning that “collateral levels are too low”.
* Brussels intends to penalise trading that is not via a central counterparty by imposing extra capital charges on those not using a middleman.
* Watchdogs could set position limits to stop violent price swings or runaway betting.
* It may become compulsory to trade standardised derivatives through a clearing house, although officials are still grappling with definition for “standardised”.
* The EU wants to set up electronic warehouses for all off-exchange business.

The proposals may disappoint some as they lack much detail. Brussels is keeping recommendations vague as mandarins tread cautiously around a complex issue that is contentious for banks and industry.

Based on a draft of the document seen earlier by Reuters, some experts question whether it is realistic to drive trading through central clearers.

“Much of the market is companies or financial firms designing derivatives on an ad-hoc basis, products which can change daily,” said Karel Lannoo, a financial services expert with think tank, the Centre for European Policy Studies.

“So how can you clear these through central counterparties? There are a lot of things the EU needs to clarify.”

Others are more critical. “It is not surprising that they find it so difficult to draft regulations which are relevant to the market place,” said Nicholas Veron of think tank Bruegel.

“There is a strong disconnect between the financial community and Brussels.”

European officials want to make some proposals law next year although parliamentarians may struggle to deal with a welter of legislation that spans banker bonuses to the creation of new super-watchdogs for European lenders.

Normally, it takes two to three years for such rules to come into effect.

As with much of the rest of its financial sector shake-up, the EU is relying on the U.S. to take a hard line so that tough new European rules do not force the region’s banks into exile.

The changes will affect banks such as Goldman Sachs and Morgan Stanley, for whom the market is a big money spinner.
(Editing by Patrick Graham)

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