The Committee recognise the economic and commercial value of derivatives instruments but acknowledge that the derivatives market, which had a global net value of around $25,000bn in 2009, has the potential to destabilise the financial system in the EU.
This report examines the European Commission’s Communications on Ensuring efficient, safe and sound derivatives markets. The regulation of derivatives markets isa complex subject. The Committee had only a short time to complete this inquiry, and doesnot attempt to come to definitive conclusions on any of the issues found in thisreport but rather to highlight key points in the forthcoming discussions onregulation of this complex area.
Derivatives are used by businesses to hedge against risks outside of their control, for example fluctuations in commodity prices. However, they are also used as tools for financial speculation. The lack of transparency in the derivatives market and the failure to identify a build-up in risk can cause market instability.
The Committee has found that the Commission proposals for increasing transparency in the socalled Over-the-Counter (OTC) derivatives market (see paragraph 8), through reporting OTC derivatives contracts which are not centrally cleared to a trade repository, will go some way to addressing concerns that the OTC derivatives market is opaque and ineffectively supervised. We also found support amongst witnesses for increased use of standardised contracts (see Box 6) and of central clearing (see paragraph 63). However, there are questions as to what types of contracts will be covered by the Commission’s definition of derivatives. A consequence of a wide definition could be to extend application of the regulation to derivatives used by non-financial businesses that have little effect on financial stability.
The Commission suggestion that central clearing for all standardised products should be mandatory did raise some issues. This proposal if adopted could increase risk by forcing clearing houses to clear products for which they cannot manage the associated risk effectively. Moreover, not all derivatives contracts are suitable for standardisation. Applying capital charges to encourage standardisation, rather than on a basis proportionate to risk, could have adverse effects on stability and increase the costs of using derivatives to manage risk.
The Committee has found that the EU would be an appropriate level for regulation for minimum standards for central counterparties, provided that the standards mirror those developed at a global level. However, the suggestion of the Commission that the European Securities and Markets Authority (ESMA) would be an appropriate body to conduct authorisation and supervision of central counterparties met with some opposition from witnesses. We found that, in the absence of any crossborder fiscal burden-sharing arrangements for failing financial institutions, central counterparties cannot be supervised at an EU level because the EU itself does not have the financial resource within the budget to bail out a large central counterparty.
Overall the Committee welcomes the apparent direction of the Commission’s proposals. The Committee will scrutinise these in detail when they emerge in the form of a draft proposal.
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