Flesh is being added to the bones of the proposed regulation to cover legislation of the vast derivatives markets in the EU, and the European Parliament's EP Economic and Monetary Affairs Committee (ECON) is generally welcoming of the tough stance put forward by its co-ordinating MEP.
Werner Langen called for a motion from the European Parliament not to pull its punches on legislating for "safe and sound derivatives markets". In a draft report, the German centre-rightist politician notes that at the end of 2009, the volume of over-the-counter (OTC) derivatives amounted worldwide to $605trn (€443trn). He draws attention to the fact that "as a result of excessive leverage, OTC derivatives have helped to make large market participants mutually dependent in an opaque manner".
Members of ECON, at a meeting in Strasbourg, welcomed their rapporteur's theme. They argued that the risk element in derivatives should be expressed more clearly in their price, while a clear distinction should be made between the use of derivatives by companies and their use by financial institutions. MEPs placed a strong emphasis on how to deal with credit default swaps (CDS).
"Those who have benefited from the high opacity in this area are not going to welcome us with open arms," said Langen, who also wishes to expand the remit of the European Securities and Markets Authority's (ESMA), the authority set to take over from the Committee of the European Securities Regulators. Langen wants ESMA supervision of trade repositories being proposed for clearing eligible derivatives.
ECON will consider amendments to the proposals on 27 April, followed by a vote on the draft resolution on 4 May. European Commission proposals for legislation are expected by mid-year. This could be partially accomplished during revisions due this year to the existing Directive on Markets in Financial Instruments (MiFID). MiFID could take in such OTC matters as transparency, investor protection, and trading platforms, or ‘venues', that is clearing houses/exchanges in this case, trade repositories.
Representatives of EU member states meeting in the Council of Ministers have also been recommending that derivatives trading could also be covered in the Capital Requirements Directive (CRD), and the Markets Abuse Directive (MAD). There is also talk in Brussels of inclusions in a forthcoming directive on clearing and settlement, a version of which is expected on 12 July. Furthermore, there could be a separate directive to cover trade repositories. However, the Commission is currently assessing its options for the legislation's final legal form.
In any case, ECON's welcome of the tough stance of Langen adds strength to the Commission's recommendation for radical reform, which in fact is already backed by the Council. Here, the Council is generally in favour of what it describes as a "paradigm shift in the Commission's approach, ‘namely moving from so-called light-handed regulation' to a more ambitious... policy".
In a series of working group meetings the national government representatives are being asked to mull over various technical options in a text proposed by the Commission. At one working group meeting involving the Commission and Council, the Council was asked for its reaction on how to clear eligible (standardised) derivatives through clearing houses, CCPs.
As for ‘tailor-made' (non-standardised) OTC derivatives, member states have also been asked for their reaction to suggestions that legislation could include the requirement that investment firms - and others executing derivatives transactions not cleared by a CCP - report them to a trade repository no later than the following working day.
In a recent Brussels think tank policy brief from the Centre for the European Policy Studies (CEPS), Karel Lannoo warns that, while current proposals in the EU and US are driven by similar intentions, the devil is in the detail. In the end the regulatory approaches of both parties could diverge substantially. For instance, the US position includes a wide range of exemptions from regulation.
The CEPS chief executive officer explains that the Securities and Exchange Commission and the Commodity Futures Trading Commission will have the final word on whether a type of derivative should be eligible for central clearing. But, overall, OTC derivatives will be gradually pushed towards centralised clearing, via derivatives clearing organisations (DCOs).
Lannoo notes that the EU position does not at present differentiate between ‘standardised' products and the sub-category, ‘eligible' products. The proportion of CCP-eligible products by no means covers all standardised contracts. He believes that, as in the US, all standardised contracts may eventually be pushed on to the CCPs. The incentive to standardise (in order to meet eligibility criteria) could be a double or triple capital requirement for non-standardised contracts.