EU Derivatives regulation efforts cautiously welcomed
31 March 2010 (updated on 22 April 2010)
The House of Lords EU Committee have today supported Commission plans for EU regulation of Over The Counter (OTC) derivatives (those that are traded directly between two parties without going through an intermediary) but believe that regulation of Central Counterparties (CCPs) of derivatives contracts should be consistent with a global approach.
- Report: The future regulation of derivatives markets: is the EU on the right track?
- House of Lords EU Sub-Committee on Economic and Financial Affairs
In their report the Committee recognise the economic and commercial value of derivatives instruments but acknowledge that the derivatives market, which had a global net value of around $25,000bn in 2009, has the potential to destabilise the financial system in the EU. They state that a balance must be struck between improving stability without increasing the costs of using derivatives to a level that becomes prohibitive.
The Committee support the European Commission’s proposals to increase transparency in the OTC derivatives market by encouraging the use of trade repositories to record OTC derivatives contracts and ensure all trades are reported. The Committee say that this should help reduce systemic risk by allowing regulators to get a comprehensive picture of exposure in the derivatives market and allow supervisors to identify accurately the misuse of derivatives.
The report also sets out the Committee’s support for increased standardisation in derivatives products. They argue that standardised contracts can improve transparency and stability in the OTC market. However they stress that not all products can be standardised and that room must be left for bespoke products to ensure an efficient market.
The Committee also considered CCP clearing of derivatives, where the contract is split in two, with one contract between the buyer and the CCP and a second between the seller and the CCP. The report agrees that regulation for minimum standards for CCPs should take place at EU level, provided this mirrors globally developed standards. However, the EU is not currently an appropriate or realistic level to undertake supervision of CCPs as it does not have the financial resources to bail out a large CCP if it were to fail.
The Committee consider the use of derivatives by non-financial businesses and point out that these derivatives are inherently less risky as the businesses that use them have a close interest in the value of the underlying assets. Derivatives play an important role in allowing companies to hedge against risks outside of their control and focus on their core business. The Committee argue that the Commission’s proposals could adversely penalise the use of this type of derivative and they are pleased that the Commission has confirmed to them that they will consider this issue in their impact assessment.
Commenting Baroness Cohen, Chairman of the Lords EU Sub-Committee on Economic and Financial Affairs, said:
"The derivatives market has important economic and commercial value. However, it is a massive industry that has the potential to destabilise the financial system in the EU unless it is properly regulated.
"The European Commission’s proposals for increasing transparency in the OTC market are to be welcomed as they will increase transparency and ensure all trades are reported to supervisory bodies. We also support proposals for standardisation of contracts as long as this will still allow flexibility where appropriate.
"We believe that it is appropriate for the EU to regulate for minimum standards of CCPs, but this must be coordinated with the global approach. However, as the EU does not have the financial resources to bail out a large CCP if it were to fail, supervision of CCPs is likely to remain at a national level."