09 February 2012

Reuters: How will the EU regulate derivatives trading?

Under the new law agreed by European Union diplomats and the European Parliament on Thursday, regulators will push for more standardisation, reducing the market for individually designed derivative instruments. (Includes quote from Graham Bishop.)

More standardisation makes it easier to clear them centrally, on an exchange or through a central counterparty, where they can be recorded and monitored by regulators. Clearing houses will provide a safety net, by stepping in should either buyer or seller to a trade go bust. Some analysts fear, however, that this structure will concentrate risks. Those who continue to trade on the informal over-the-counter market face higher capital charges to reflect the risk, adding to their costs.

"The biggest change is that more derivatives will be standardised and cleared centrally", said Graham Bishop, who advises banks on European financial policy. "That means that capital will have to be retained to cover the risk of these transactions. This should prevent another Lehman, whose collapse left those who had signed up to derivatives deals with it carrying the costs", he said. "It will make hedging currency shifts, for example, more expensive because capital comes at a cost. But previously, there had not been enough capital in the system to cover the risks."

The new law requires detailed information on over-the-counter derivative contracts to be reported to trade repositories, where they are accessible to supervisors, and which must publish aggregate market positions. There is also a new code on how much capital the parties to a derivative trade must hold, as well as wider disclosure of prices. The new EU law is in keeping with a commitment by leaders of the world's top 20 economies in 2009 to herd derivatives traded off exchanges onto regulated platforms from the end of 2012.

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