Lords fear derivatives threaten financial services

The House of Lords European Union committee today (31 March) supported Commission plans for EU regulation of over the counter (OTC) derivatives (those that are traded directly between two parties without going through an intermediary) but believe regulation of central counterparties (CCPs) of derivatives contracts should be consistent with a global approach.

In their report, entitled The future regulation of derivatives markets: is the EU on the right track, the committee recognise the economic and commercial value of derivatives instruments but acknowledged the derivatives market threatened the financial system of the continent.

The committee stated a balance must be struck between improving stability without increasing the costs of using derivatives to a level that becomes prohibitive.

The committee supported the European Commission's proposals to increase transparency in the OTC derivatives market by encouraging the use of trade repositories to record OTC derivatives contracts and ensure all trades are reported.

The committee stated this should help reduce systemic risk by allowing regulators to get a comprehensive picture of exposure in the derivatives market and allow supervisors to identify accurately the misuse of derivatives.

The report also sets out the committee's support for increased standardisation in derivatives products.

The committee argued standardised contracts can improve transparency and stability in the OTC market.

However, the committee stressed that not all products can be standardised and that room must be left for bespoke products to ensure an efficient market.

Baroness Cohen, chairman of the Lords EU sub-committee on economic and financial affairs, said: "The derivatives market has important economic and commercial value. However, it is a massive industry that has the potential to destabilise the financial system in the EU unless it is properly regulated.

"The European Commission's proposals for increasing transparency in the OTC market are to be welcomed as they will increase transparency and ensure all trades are reported to supervisory bodies.

"We also support proposals for standardisation of contracts as long as this will still allow flexibility where appropriate.

"We believe that it is appropriate for the EU to regulate for minimum standards of CCPs, but this must be coordinated with the global approach.

"However, as the EU does not have the financial resources to bail out a large CCP if it were to fail, supervision of CCPs is likely to remain at a national level."