Draft law on standardising European derivatives published

A European Union lawmakers' committee has voted overwhelmingly in favour of a draft law to standardise derivatives so they can be moved through central clearing houses to reduce risk and improve transparency.

Derivatives trading, much of it transacted between banks, is used to guard against damaging moves in interest rates, inflation or commodity prices, but their open ended and opaque nature made it hard to assess exposures in the $600 trillion sector when US bank Lehman Brothers collapsed at the height of the financial crisis.

The devastating impact of that uncertainty on financial markets left regulators determined to shine a light on the sector to avoid any repeat.

The European Parliament's economic affairs committee meeting in Brussels voted by 36 to 1 in favour of the proposal, but there remain several hurdles before it becomes law.

‘This trillion dollar grey zone must become more transparent. We are in favour of transparency and security, especially of derivatives which are traded over the counter and might create turbulence in financial markets,’ said Werner Langen, the German lawmaker steering the draft through parliament.

Under the deal brokered by lawmakers, the obligation to move derivates through a central clearing house would apply to much of the $600 trillion derivatives traded off an exchange or over the counter while reporting requirements would be imposed on all derivatives trades, including those on exchanges.

Britain, Europe's top derivatives trading centre, wants the law to cover all derivatives, since the rules enshrine a choice of clearing house, a choice the UK says should be extended to those who trade on an exchange, too.

European Union states have joint say on the draft law, but a final deal looks months away after lawmakers raised the stakes by deciding to hold a full parliament vote in July before kicking off a second reading and negotiations with EU states.

EU Internal Market Commissioner Michel Barnier, who wrote the draft law, said he hopes progress will be swift and he cautioned lawmakers that a second reading would add another six months as the global end 2012 deadline loomed.

This leaves banks and markets in limbo, especially as US regulators are also having difficulty meeting the global deadline with their new rules. The US reform also goes further and includes regulating how derivatives are traded as well as cleared and reported, adding further uncertainty.

The EU will address trading in a separate reform known as the Markets in Financial Instruments Directive (MiFID), but this may not be published until September, industry officials said.

If approved by competition authorities, the tie-up will combine Europe's two main derivatives exchanges LIFFE and Eurex, which account for over 90% of listed derivatives trading.

Eurex has its own clearing house, which would stand to gain extra volumes, probably at the expense of Anglo-French LCH.Clearnet.