EU derivatives plan welcomed, but lacks detail

Market participants have expressed support for the European Commission's communication on over-the-counter derivatives, published on July 3, but called for more solid research on some of the policy proposals in the report.

The communication, Ensuring efficient, safe and sound derivatives markets, renews calls for greater standardisation of derivatives and the use of central counterparties (CCPs) for clearing, but also suggests a central trade repository and greater use of regulated exchanges and trading venues could be effective tools in increasing the transparency and stability of the derivatives market. (See EC looks to move standardised OTC derivatives onto exchanges, Risk News, July 3).

"The current crisis has highlighted the need to deal with OTC derivatives markets to allow them to fulfil their economic role in a way that does not endanger the stability of the system," the EC said on July 3. While industry associations and market participants have broadly expressed their support for the main points in the paper, some stress the devil will be in the detail of implementation.

"We're pleased the EC wants to consult with the industry on this, rather than the heavy handed way in which it has approached the regulation of hedge funds," said Andre Allee, derivatives partner at law firm Simmons & Simmons in London. "The view from 10,000 feet looks fine, but how it looks closer to the ground is what's going to be important to most of our clients. So until we see a bit more detail around some of those issues, there are still a number of questions that the paper doesn't address."

One grey area is standardisation. While the paper calls for greater standardisation of OTC derivatives as a means of increasing operational efficiency and reducing risks, and said it would encourage industry efforts to increase standardisation of instruments, EC officials refused to define exactly what they meant by standardised contracts. "Further clarity will be required here, particularly in relation to those products where standardisation is going to be difficult to achieve," said Allee.

The plan to encourage greater use of regulated exchanges could prove controversial for complex products, but officials stress it is far from being a concrete proposal at this stage. "The overall exercise is a consultation, it shouldn't be seen as a foregone conclusion," said one industry association official who was involved in the consultation. "Maybe the nuance is that it's the next logical question – whether it's the next thing they ask the industry to sign a commitment on is another matter."

Inside the EC, the focus is on standardisation as the top priority, with the push to exchanges being much further off at the moment. "Standardisation is top of the list because it is the prerequisite for everything else, and in terms of counterparty risk mitigation, it's the CCP that is important," said an EC official. "For anything not cleared through a CCP, a trade repository would increase transparency, and the use of an exchange or trading platform would be the icing on the cake. But for the time being it's just an idea being floated – before proposing anything in that direction, we really need to be sure it can be done."