The European Commission (EC) appears intent on pushing through sweeping reforms of the European derivatives market, despite fears of unintended consequences voiced by corporate end-users.
At a conference in Brussels on September 25, senior dealers, supervisors and economists came together to discuss a communication issued by the EC in July, which proposed increased standardisation of over-the-counter products, along with greater use of clearing platforms, central trade repositories and a possible push towards exchange-traded instruments. The proposals mirror many of those made by the US Treasury earlier this year, but derivatives end-users from companies including Lufthansa and Rolls Royce complained that reforms on both sides of the Atlantic were being crafted without taking the needs of corporates into account.
"The idea of a derivative - writing a contract for a simple transfer of risk - is centuries old. Designing proper regulation is far more intricate than one would expect for a centuries-old idea. Many companies have come to love and need derivatives. And they are expressing their worries that a rigorous approach would make their hedging more expensive and thus expose them to more risk," admitted EC internal market and services commissioner Charlie McCreevy, speaking at an event in Brussels before the conference began.
Asked whether corporate end-users would be exempt from any of the rigorous rules being planned in the US, keynote speaker Gary Gensler, chairman of the US Commodity Futures Trading Commission, offered little reassurance. "Our belief in the US is that we need to cover the entire market, and that means corporates, small municipalities and non-profits that use these markets to hedge," he said. "We see no way to exclude the actual users of the products."
Some dealers suggested the idea of incentivising the market to use standardised contracts that could be centrally cleared missed the point, and wrongly assumed a non-standardised contract meant a complex and risky one. "Non-standard can mean something as simple as the maturity of the contract is December 31 as opposed to December 20, which is the standard date. But a corporate might have a very legitimate need for hedging something out to December 31 - it might have a delivery of products or it might have a bond delivery at that date," argued Blythe Masters, head of global commodities at JP Morgan in New York.
If the EC pushed ahead with higher capital charges and collateral requirements for non-standardised products that cannot be centrally cleared or traded on an exchange, corporates would ultimately bear the cost, she argued. "It is misleading to think this will not increase cost and increase credit requirements for corporates. Categorically it would," she said.
Other areas of concern included the advent of central clearing for credit default swaps. While the EC welcomed the launch of two central counterparties (CCPs) for clearing - Ice Clear Europe and Eurex Credit Clear - dealers and regulators cautioned central clearing was not a panacea to the market's problems.
"Clearing is a very positive development, but risk is now concentrated on a clearing house and we have to now be very aware of a future problem... we need to focus on their safety and soundness," argued Pablo Salame, co-head of trading and sales at Goldman Sachs.
Some panellists suggested CCPs should be centrally regulated by a pan-European authority to ensure they meet the needs of traders in multiple jurisdictions. The European Securities and Market Authority, a powerful new body the EC has proposed to replace the Committee of European Securities Regulators (Cesr), would be one candidate to supervise European CCPs. Mario Nava, head of the EC's financial market infrastructure unit, said this proposal remained an "open question", pending approval from other European Union institutions.
The use of central trade repositories emerged as another area of contention. While the industry is taking steps to set up repositories to store OTC trade data, enabling regulators to have a more complete view of where risks lie, the question of how many repositories are needed and where they should be located remains unresolved.
Eddy Wymeersch, chairman of Cesr, said there was strong support for having a European repository in addition to any US initiative, stressing it would be unwise to store all global data in one utility. But Theo Lubke, head of financial infrastructure at the Federal Reserve Bank of New York, insisted appropriate resiliency could be built into a repository to avoid the loss of data, and argued they should be set up by asset class rather than geography to avoid data replication.
"I can see a world develop where there are multiple repositories for each asset class, but to say there needs to be a repository in this jurisdiction as well as that jurisdiction for the same type of derivative leads to the duplication of infrastructure, as well as lack of clarity on where you're reporting to and perhaps how that gets consolidated back up to the regulators," Lubke argued.
The conference ended a three-month consultation on the derivatives communication, and the EC now plans to publish operational conclusions on its proposed way forward by the end of October. "We hope that will be possible to achieve because the EC's formal legal mandate ends at the end of October, so time in a way is not on our side," said David Wright, deputy director-general of the internal markets and services directorate-general at the EC.