EU mulls cap on speculative derivative trades

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The European Union may propose rules within weeks to cap the size of individual trades by speculators in derivatives, blamed for exacerbating the economic crisis, said sources with knowledge of the matter.

Under the plans, the new regime could allow watchdogs to limit big trades in derivatives such as Greek debt default insurance. Some suspect speculators accelerated the rising cost of this insurance, pressuring Athens to turn to European neighbours and the IMF for a 110 billion euro bailout.

"They want transparency," said one source, commenting on planned EU rules for an uncontrolled market where the only record of many multi-million euro deals is a fax. "It could be useful to give supervisors the power to impose [position] limits."

Michel Barnier, the EU commissioner in charge of a financial services overhaul, has pledged to "shine a light" on an "immense and opaque market".

Sources familiar with his plans told Reuters that Barnier is now examining how to give watchdogs the power to impose limits on trades in derivatives, which give investors the option to buy anything from currency to gas at a fixed price in the future.

Under a model which would closely resemble the approach being taken in Washington, traders could be stopped from building up a large position that could let them swing prices in their favour.

The former French foreign minister is likely to impose a strict regime on recording derivative trades and gradually push the market onto exchanges or central warehouses and under the close watch of supervisors.

It would be the first rules for trading in instruments whose value is linked to an asset such as currency, a market which ballooned from less than $100 trillion in 1998 to roughly $700 trillion in 2008, just before the economic crash.

The unsupervised, off-exchange derivatives market is now in the hands of less than a dozen deal brokers such as Goldman Sachs and Deutsche Bank.

Under the microscope

The power of derivative speculators, including hedge funds, has been under ever closer scrutiny since the unfolding of the Greek debt crisis.

Pressure is building for a regulatory clampdown after German Chancellor Angela Merkel and French President Nicolas Sarkozy accused such investors of rocking fragile markets.

Many believe speculators rushed to buy large chunks of Greek debt insurance or credit default swaps, adding to the panic that pushed the country to the brink of financial collapse.

But as there is no central record to show who was buying and selling the insurance, attempts to pin responsibility on individual betters by German financial watchdog Bafin and others have lead nowhere.

In America, the authorities want to impose position limits on traders in energy markets to prevent price manipulation.

Barnier will propose his rules as soon as June, firing the starting gun on negotiations between the European Union's 27 countries and parliament on the shape of a new law for the industry.

Trading of credit default swaps, which is set to receive special attention in further rules to be outlined later this year, rocketed from roughly $900 billion in 2001 to more than $62 trillion in 2007.

(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 financial 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: Commission to publish draft derivatives legislation.
  • October: Commission to publish draft legislation to curb Credit Default Swaps.

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