Wednesday, October 14, 2009

EU wary on some derivatives market reforms-sources

Posted on Reuters by Huw Jones:

Banks should be "incentivised" but not forced to shift privately-negotiated derivatives contracts onto exchanges to cut risk, the European Union's executive will say next week, according to people familiar with the situation.

The European Commission is expected to publish a policy discussion paper on regulating the $450 trillion over-the-counter (OTC) derivatives markets on Oct. 20.

"I think they want to keep it a reasonably high level so they have room for manoeuvre. Expectations for October 20 were for more detail but the industry will be disappointed," a source with knowledge of the paper said on Tuesday.

The largely unregulated market includes credit default swaps (CDS), which are used to bet on whether a company will default on its bonds and have been blamed for amplifying last year's severe financial crisis that hammered economies worldwide.

The Commission published a preliminary paper in July which focused on the need for standardisation and central clearing of CDS contracts, saying the case has yet to be made on mandatory exchange trading.

"It hints at exchange trading by using the word incentivising transition to try to get more use of standardised products," the source said of next week's paper.

The July paper was more open on the issue of exchange trading, only saying it needed further study.

Incentives would likely comprise heavier capital charges on banks which trade OTC contracts that are not standardised or centrally cleared, the source added. Cleared contracts already have a zero weighting for capital requirements.

The latest paper is also expected to push for greater transparency and for a central data repository. It reflects global efforts to regulate derivatives and other lightly supervised parts of the system.

In September the Group of 20 (G20) major nations, which includes the European Commission, agreed that all standardised OTC contracts should be traded on exchanges or platforms where appropriate, and cleared centrally by the end of 2012 at the latest.

Non-centrally cleared contracts should be subject to higher capital requirements, the G20 said.

Industry officials said the Commission will not flesh out its derivatives policy too much at the moment for several reasons.

-- a new Commission is due to take office in coming weeks and the outgoing executive cannot tie its hands by making firm legislative proposals at this stage.

-- the U.S. position is shifting. A government bill wants mandatory exchange trading, while the two other draft bills say it should be optional or offer opt-outs. The G20 and industry want a common transatlantic approach to avoid regulatory arbitrage.

-- the G20 said last month the Basel Committee on Banking Supervision has until June 2010 to draft tougher capital requirements on OTC contracts that are not centrally cleared.

-- there is debate about what standardisation is, with users telling policymakers they want to keep non-standardised contracts to hedge risks effectively.

-- a Commission official has said mandatory exchange trading would conflict with an EU law on competition in share trading

-- the Committee of European Securities Regulators (CESR), which groups national watchdogs in the EU and advises the Commission, said last month it does not want to impose exchange trading on OTC contracts.

Central clearing for CDS contracts in Europe began in July.

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