At a meeting with industry groups and regulators on October 22, the European Commissioner for internal markets and services, Charlie McCreevy, outlined his intention to move credit derivatives away from the over-the-counter market and under regulatory control.
A European Commission (EC) official who attended the meeting told Risk a working group for derivatives - to be chaired by Martin Power, McCreevy's head of cabinet - has been established, with its first meeting scheduled for November 5.
"There are two main objectives: first, the commissioner wants the group by the end of the year to establish concrete proposals as to how the risks from credit derivatives can be mitigated," the official says. "In particular, he wants ambitious plans to move credit default swaps (CDSs) onto centralised clearing facilities. More generally, he wants the group to take a systematic look at derivatives markets in terms of the lessons learned from the current turmoil."
The official added that the EC's goal is "to shift the majority of CDSs" from bilateral OTC arrangements to central clearing houses. McCreevy told attendees at the October 22 meeting that although he wanted the solution to be principles-based, comply with monetary and regulatory objectives and be implemented willingly by market players, the EC "would not refrain from imposing legislation to meet that objective if the industry does not deliver".
In terms of the broader objective, the working group was asked to finalise plans by April 2009 for how the overall derivatives market can move forward. Beyond credit derivatives, McCreevy told the meeting he wants to see standardisation and risk mitigation in the medium term for "less liquid" derivatives instruments in other asset classes, as well as for the industry to look at pre- and post-trade transparency requirements. In addition, the working group should ask whether the current Capital Requirements Directive is adequate in its treatment of derivatives.
McCreevy had already hinted at the EC's plans to transform credit derivatives from being a predominantly OTC business in a statement published on October 17. He said the market was "little understood by those outside of it", adding: "I am not convinced that more derivatives could not be standardised."
The commissioner thought September's collapse of a major derivatives dealer, Lehman Brothers, had brought to light the need for a central clearing house. "In the event of the failure of a significant party to honour its obligations, there could be serious knock-on effects to other financial players. The opaqueness of these products leads to nasty surprises when things go wrong. Regulators need to have a much better view of where the real risks in these instruments lie," McCreevy said.
Regulatory representatives from the Committee of European Banking Supervisors, the Committee of European Securities Regulators, the European Central Bank and the Committee of European Insurance and Occupational Pension Supervisors attended the October 22 meeting.
Joining them was the full range of industry groups, including the International Swaps and Derivatives Association, the European Association of Central Counterparty Clearing Houses, the Federation of European Securities Exchanges, the Alternative Investment Management Association, the European Fund and Asset Management Association, the European Banking Federation, the European Insurance and Reinsurance Federation, the London Investment Banking Association and the Securities Industry and Financial Markets Association.
Also present were officials from Liffe, the derivatives arm of NYSE Euronext. Each group was due on October 24 to nominate one representative to sit on the EC's working group for derivatives.
Eraj Shirvani, chairman of Isda and the co-head of European credit sales and trading at Credit Suisse, described the meeting as constructive. "Participants are reviewing progress in operational efficiencies, and will seek to examine the exact nature and extent of challenges the markets are facing in ensuring operational and systematic security, as well as where further progress might be needed," comments Shirvani.
To that end, Shirvani says Isda will continue to push for a European Union directive that would reinforce the bilateral close-out netting regime in the region.
Despite McCreevy's warning about putting in place legislation for centralised clearing if market participants do not deliver, private initiatives are rapidly moving towards such a practice.
Four groups - Eurex, NYSE Euronext, the CME Group in conjunction with Chicago-based Citadel Investment Group, and the Clearing Corporation in partnership with the Intercontinental Exchange - have confirmed plans to launch CDS clearing facilities in the coming months.
- Rob Davies.