Wednesday, December 16, 2009

U.K. to Say Too Much Extra Capital Would Kill Off Derivatives (BN)

Original posted on Bloomberg by Gonzalo Vina and Nandini Sukumar:

The U.K. will outline plans to prevent over-the-counter derivatives, or those traded outside exchanges, being priced out of the market by European Union proposals, a Treasury official said.

A study published in London by the Treasury and the Financial Services Authority today will set out plans to ensure derivatives too complex to be traded on an exchange or through a central clearing body aren’t made uncompetitive by high capital requirements demanded by the EU.

The U.K. gave qualified support to EU proposals to oversee derivatives in a report published in September. The U.K. doesn’t support the forced use of standardized contracts for all trades, or using demands for extra capital as a punishment rather than as a weight against perceived risk.

The Treasury backs the EU plan to get some derivatives traded on exchanges although it wants European authorities to recognize that there are instruments -- including life insurance products for people with profiles different from the wider population -- that can’t be traded centrally. Forcing investors to keep high levels of capital in reserve would price the products out of existence, the official said.

EU proposals in July were an attempt to cut risk in the $605 trillion over-the-counter derivatives market after the collapse of banks such as Lehman Brothers Holdings Inc. last year. U.S. President Barack Obama released a similar plan in June that would require standardized over-the-counter derivatives to be guaranteed by clearinghouses.

U.S. Proposals

Obama’s administration proposed regulatory changes in August, including imposing higher capital and margin requirements on derivatives markets and requiring certain contracts to be processed through clearinghouses. The European Commission has outlined plans to standardize derivative contracts, proposed operating standards for central counterparties and said derivative traders must record all transactions that aren’t centrally cleared.

Derivatives are financial instruments used to hedge risks or for speculation. They’re derived from stocks, bonds, loans and commodities, or linked to specific events like changes in interest rates. Options and futures are the most common types of derivatives.

Clearing is the process of verifying that a buyer has funds to execute a trade. Some clearinghouses also act as central counterparties to every buy and sell order executed on an exchange, removing the risk that a trader defaults on his obligation in a transaction. The largest futures exchanges, including CME Group Inc., Eurex and Intercontinental Exchange Inc., all offer derivatives clearing.

The U.K.’s FSA said Nov. 10 it’s unlikely to prescribe which contracts must be processed through a clearinghouse.

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