The report states that the mandatory registering of CDS, with all OTC derivatives, in trade repositories, laid down in the upcoming European Market Infrastructures Legislation will dramatically improve transparency in this market.
Market infrastructure: Credit default swaps, OTC derivatives markets and Credit Rating Agencies
Credit default swaps
15. A deep debate about the functioning of Credit default swaps (CDS) markets has arisen in the last few years, especially with regard to the role played by CDS. The debate on CDS is framed within the design of market infrastructure, as one of the main shortcomings of the CDS market is the lack of post-trade transparency. Prices and trading volumes in this type of product are neither disclosed to market participants nor to competent authorities. As a result, the ability of participants and supervisors to analyse the market is hampered, leading to an artificial increase in the uncertainty that naturally follows crises like the current one. Reliable information – periodically updated - on the volume, price, type of counterparty, type of contract, and collateral required, among others, is needed. In the European Union, the upcoming European Market Infrastructure Legislation represents one of the key elements of the framework for transparency requirements. The mandatory registering of CDS, like all OTC derivatives, in trade repositories, laid down in the European Market Infrastructures Legislation will dramatically improve transparency on this market.
16. This will ensure that competent authorities have access to that information, so that abusive conducts in the market can be identified and sanctioned.
17. Finally, taking into account that the CDS market is featured by a high level of counterparty risk, future measures could also focus on making trading on exchanges or on electronic trading platforms and clearing mechanisms for eligible CDS contracts mandatory and ensuring an adequate risk management of non-standardised contracts.
OTC derivatives markets
18. Although derivatives play a useful role in the economy by transferring (all or part of) the risks inherent to economic activity from economic agents who are not willing to bear them to those who are, they also contributed to the financial turmoil by allowing leverage to increase and by interconnecting market participants, a fact which went largely unnoticed because of the lack of market transparency, resulting chiefly from the predominant over-the-counter (OTC) market structure. The June 2009 European Council called for "further progress to be made in the regulation of financial markets, notably on transparency and stability of derivatives markets." On 25th September 2009 G-20 leaders agreed that: "All standardised OTC derivatives contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at latest. OTC derivatives contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements".
19. Considerable progress has been made by the Commission since its October 2009 Communication in respect of mandating central counterparty (CCP) clearing for eligible derivatives contracts, mandating reporting of OTC derivatives transactions to trade repositories (TRs) and establishing the requirements CCPs and TRs need to comply with to ensure their safety, soundness and efficiency. Some open issues remain in respect of the reporting obligation to TRs, the institutional arrangements between competent authorities and the location of TRs. We are looking forward to the legislative proposal the Commission will be presenting this summer, which will be addressing all these issues.
Credit rating agencies
20. Credit rating agencies (CRAs) are considered to have failed to reflect properly the risks embedded in structured products as well to reflect early enough the worsening market conditions, and therefore to have contributed significantly to the problems in financial markets. Despite their significant importance for the functioning of the financial markets, they were only to a limited extent subject to Community legislation/oversight before the financial crisis.
21. The European Councils of 20 June and 16 October 2008 called for a legislative proposal to strengthen the rules on credit rating agencies and their supervision at EU level, considering it a priority to restore confidence and proper functioning of the financial sector. In November 2008, the Commission made a legislative proposal for a Regulation focussing on the supervision, integrity, quality and transparency of the activity of CRAs, which was adopted on 16 September 2009. Both regulators and credit rating agencies are getting ready to ensure a smooth implementation of these rules within the prescribed timeframe, i.e. credit rating agencies will have to comply with the new rules by 7 September 2010.All the rules of the Regulation will be applicable as of December 2010.
22. In addition, the Commission will present shortly a legislative proposal on centralised EU supervision on credit rating agencies including rules on transparency in order to increase competition and entrusting the European Securities and Markets Authority (ESMA) with exclusive supervisory powers over credit rating agencies registered in the EU.
23. Also in the US, there is there is currently legislation in both the House of Representatives and Senate that would further enhance regulation of CRAs and would also enhance convergence between the EU and US regulatory framework.
© ECFIN
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