Derivatives trading, much of which takes place between banks, is used to guard against damaging moves in interest rates, inflation or commodity prices. But their open-ended and opaque nature made it hard to assess exposure in the $600 trillion sector when US bank Lehman Brothers collapsed at the height of the financial crisis.
The devastating impact of that uncertainty on financial markets left regulators determined to shine a light on the sector to avoid any repeat.
The European Parliament's economic affairs committee, meeting in Brussels, voted by 36 to 1 in favour of the proposal, but there remain several hurdles before it becomes law.
"This trillion-dollar grey zone must become more transparent," said Werner Langen, the German centre-right lawmaker (European People's Party) steering the draft through parliament.
"We are in favour of transparency and security, especially of derivatives, which are traded over-the-counter and might create turbulence in financial markets," Langen said.
Under the deal brokered by lawmakers, the obligation to move derivates through a central clearing house would apply to much of the $600 trillion derivatives traded off an exchange – or over the counter (OTC) – while reporting requirements would be imposed on all derivatives trades, including those on exchanges.
Britain, Europe's top derivatives trading centre, wants the law to cover all derivatives, since the rules enshrine a choice of clearing house, a choice the UK says should be extended to those who trade on an exchange, too.
"We must make sure that the obligation to clear and report trades must apply to all derivatives," UK Financial Services Minister Mark Hoban told a legal association on Monday evening.
Banks also want to be able to choose where they clear their trades.
EU states have joint say on the draft law, but a final deal looks months away after lawmakers raised the stakes by deciding to hold a full parliament vote in July before kicking off a second reading and negotiations with EU states.
"An agreement in the autumn would be possible, but for that member states have to show more willingness on market transparency," Langen said.
EU Internal Market Commissioner Michel Barnier authored the draft law and he cautioned lawmakers that a second reading would add another six months as the global deadline of end 2012 loomed.
"I hope we will be able to make progress as swiftly as possible. As you know the market moves ahead extremely swiftly, especially when it comes to derivatives," Barnier said.
This leaves banks and markets in limbo, especially as US regulators are also having difficulty meeting the global deadline with their new rules.
The US reform also goes further and includes regulating how derivatives are traded as well as cleared and reported, adding further uncertainty.
MiFID trading addressed in September
The EU will address trading in separate reform known as the Markets in Financial Instruments Directive (MiFID), but this may not be published until September, industry officials say.
Some diplomats said the UK might win out on scope in the final text if safeguards are added to ensure that clearing choice is not risky, but Tuesday's near unanimity among lawmakers will make it difficult.
Sources close to the negotiations say Germany is among a few countries with strong feelings against widening the law's scope.
The battle over the scope of regulation became politically charged because of Deutsche Boerse's planned takeover of NYSE Euronext.
If approved by competition authorities, the tie-up will combine Europe's two main derivatives exchanges LIFFE and Eurex, which account for over 90% of listed derivatives trading.
Eurex has its own clearing house, which would stand to gain extra volumes – probably at the expense of Anglo-French LCH.Clearnet.
(EurActiv with Reuters.)