Currency derivatives face new EU rules


Foreign exchange derivatives contracts will be covered by draft European Union rules due in July to cut market risks but mandatory clearing is unlikely, a senior official from the bloc's executive said on Tuesday.

The European Commission is finalising its draft measure to shine a light on the vast $615 trillion off-exchange traded derivatives market, whose opacity and risk concentration has alarmed policymakers in the financial crisis.

Trading in OTC derivatives is done bilaterally, mainly between banks but that business model faces major upheaval.

The Commission has been lobbied to leave out the $49.2 trillion FX derivatives sector on the basis they were not considered to be a contributing factor in the crisis.

"There is no case that we should exclude, a priori, FX from any legislation on the treatment of OTC derivatives," said Patrick Pearson, a head of unit at the European Commission's internal market division, which covers financial services.

"But we believe including FX in the scope of regulation does not mean it automatically falls under a clearing obligation," Pearson told a conference on clearing held by Marketforce.

EU finance ministers at the weekend called on the Commission's financial services chief Michel Barnier to make rapid progress in coming forward with new derivatives rules.

The measure will make it mandatory to centrally clear all standardised derivatives contracts to increase transparency and cut risks by including a fund in case of default.

Following pledges from the G20 group of leading countries last year, a more transparent and less risky derivatives market will emerge under the new EU rules.

The United States is also planning similar rules and is further along the legislative process. Pearson said it was vital there should be a common approach but not at any price.

"Convergence does not have to mean identical," he said, signalling there was no appetite to copy a US proposal to ban swaps desks at some banks.

Bomb proof rules

Pearson promised the biggest shake up in regulation in living memory to ensure risks are no longer underpriced.

"What we put out needs to be legally bomb proof," he said.

There would be no "one size fits all" to force clearing of all contracts as this could undermine financial stability.

The new rules will make sure clearers of all securities are "rock solid" to withstand future shocks.

Clearers were already competing on all the wrong bases at the moment – price, risk and regulation – and the new rules will ensure they have minimum levels of capital, Pearson said.

Airlines, carmakers and other non-financial users of derivatives contracts are lobbying hard to be excluded from having to centrally clear trades, a step they say will bump up costs prohibitively.

Pearson questioned their sums because non centrally cleared contracts will be subject to capital requirements whose cost will inevitably be passed on by the bank to the companies.

In any case "systemically" important transactions undertaken by corporates face a clearing obligation, he added.

The Commission has sought to introduce competition in the clearing of shares by promoting interoperability or links between clearing houses but with little progress.

The crisis has slowed things down by highlighting risks of contagion if one clearer went belly up.

Pearson told Reuters there was no appetite for interoperability in derivatives clearing but strict risk management and capital conditions would be introduced for link ups between clearers of shares and probably bonds.

The United States wants as many derivatives trades as possible moved onto exchanges and Pearson said this issue would addressed in this year's separate review of the bloc's MiFID rules on share trading.

(EURACTIV with Reuters.)

EU Internal Market Commissioner Charlie McCreevy opened an investigation into the derivatives sector in October 2008, a month after the collapse of Lehman Brothers, a bank heavily involved in the $600 trillion global derivatives market.

The advantage of derivatives is that they allow companies and governments to increase their means of managing risk. The disadvantage is that they are the top instrument for speculative operations. If used irresponsibly, they can increase risk at exponential levels, spreading the negative consequences of defaults across the markets.

Establishing central clearing houses is considered a moderate way of reducing systemic risk related to derivatives. Instead of being exchanged privately ('over the counter'), they could be processed through an intermediary, a move which is expected to improve transparency and reduce risk.

The European Commission clearly supported this approach in a communication published in July 2009 (EURACTIV 06/07/09).

  • June/July: Commission to publish draft derivatives legislation.
  • October: Commission to publish draft legislation to curb Credit Default Swaps.

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