The EC has been consulting with market participants for a year, but is now drafting legislation, to be published in September.
Meanwhile, the European Parliament – which does not initiate legislation but votes on it – adopted a resolution calling for EU rules on derivatives trading to be made clearer and tougher.
The parliament wants to reduce speculative trading and would like derivatives to be traded through “open channels that are subject to rules” as much as possible.
It called for central counterparty (CCP) clearing facilities to be strengthened and for regulators to ensure they are resilient even under a lot of stress. The resolution backed lighter regulation of over-the-counter derivatives for corporate end users, but said the new European Securities and Markets Authority (Esma) should set thresholds beyond which central clearing should be mandatory.
European legislators would like to see a ban on speculative credit default swap trading and a requirement that all CDS be centrally cleared through a European CCP.
The Parliament’s resolution is a guide to the direction the assembly wants policy to take, but the legislation is being drafted by the Commission.
Derivatives specialists have praised the EC’s openness to consulting thoroughly with market players in order to make the legislation as workable as possible. But it is still possible that parts of the law could be onerous or inconvenient for the industry.
The 25 page Public Consultation on Derivatives and Market Infrastructures, published on June 14, called for advice from the market in four areas – clearing and risk mitigation of OTC derivatives; requirements for CCPs; interoperability; and reporting obligations and requirements for trade repositories. The consultation closed on July 10.
On clearing and risk management, the EC is considering how to meet the objective agreed by the G20 leaders that “all standardised OTC derivatives should be cleared through central counterparties by end-2012 at least”.
The paper suggests that two approaches be used together to decide which contracts must be cleared.
The ‘bottom-up’ approach involves a CCP choosing which contracts it wants to clear, and submitting proposals to the competent authority supervising it. Esma would then decide whether a clearing obligation should apply to those contracts.
Under the ‘top-down’ approach, Esma and the European Systemic Risk Board would decide which contracts must be cleared.
The clearing obligation would require that financial parties clear all eligible derivative contracts with an authorised CCP, even if trading with counterparties outside the EU. CCPs would be obliged to clear contracts, irrespective of the venue of execution.
One of the most complex and fluid policy areas is interoperability – meaning participants could choose where their contracts were cleared. The document gives the impression that the EC lacks confidence in this area. It seems possible, but by no means certain, that a right of interoperability could be introduced. However, the document seems more concerned to ward off the risks that interoperability could bring.
Reporting requirements also carry some big unknowns – precisely what data the law will insist is collected by trade repositories, and how much analysis the authorities want to perform on it.