EU to launch derivatives consultation this week

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The European Union's executive will kick off public consultation on its sweeping derivatives crackdown this week with companies already warning that hedging risks could be harder under the new rules.

The long-awaited document will pose a series of key questions which will help shape a draft law the European Commission will propose by September at the latest, Patrick Pearson, a senior Commission official, told a Derivatives Week debate.

The EU and United States are introducing new rules to shine a light on the $615 trillion off-exchange derivatives markets in line with pledges made by the Group of 20 leading countries.

Reform focuses on central clearing and exchange trading of contracts to learn lessons from the financial crisis where opaque and complex derivatives played a role in the demise of Bear Stearns and Lehman Brothers banks.

The EU consultation will look at issues such as whether a contract should be banned if nobody is prepared to clear it, Pearson said.

Companies, such as airlines and carmakers, who use derivatives to hedge against risks such as adverse currency movements, are lobbying hard to escape the harshest elements of the new rules.

"I have never accepted that genuine corporates give rise to systemic risk. It's not provable or justifiable," said Richard Raeburn, chairman of the European Association of Corporate Treasurers.

Pearson said companies whose derivatives contracts pose a risk will fall within the scope of the new rules that mandate central clearing to cut risks or impose heavy capital charges on uncleared contracts.

"I think we all know which non-financial firms are trading systematically important positions," Pearson said.

Raeburn countered that companies were "pretty nimble" and able to shift trading to offshore centres.

Watching EU and US differences

Banks are watching for any key differences between the US and EU rules to exploit.

The US House and Senate are due on Thursday to start hammering out a common legal text and say they expect a speedy outcome, Michael Dunn, a commissioner at the Commodity Futures Trading Commission, told the Derivatives Week event.

"I have my doubts about that," Dunn said.

Once a common text is agreed and signed into law by President Barack Obama – with 4 July the target date – the new reforms will need detailed implementation measures by regulators such as the CFTC, which supervises derivatives markets.

Regulators will have between 180 days and a year, depending on which timeline is adopted, to finalise such measures.

"At any rate, it's a very formidable task," Dunn said.

"Industry says it will be punitive. It's not our intention to be punitive but to be fair and make sure […] taxpayers are insulated from future meltdowns," Dunn added.

Ensuring integrity of clearing houses will be the hardest task for the CFTC to grapple but rules would not be rushed, Dunn said.

The final US reform may contain a provision that will force some banks to spin off their swaps desk and impose ownership curbs on clearing houses, steps Europe is seen as being reluctant to copy.

"Ownership limits, spinning off swaps desks. Is that what we want in Europe? I ask the question," Pearson said.  

(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).

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