Annexes to COM(2009)563 - Ensuring efficient, safe and sound derivatives markets: Future policy actions - Main contents
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This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2009)563 - Ensuring efficient, safe and sound derivatives markets: Future policy actions. |
|---|---|
| document | COM(2009)563  |
| date | October 20, 2009 |
3.4. Mandating central clearing
On top of capital charges for non-centrally cleared products, the Commission intends to propose making it mandatory to clear standardised derivatives through CCPs, in line with the G20 declaration. When developing its detailed proposals, the Commission will work with its partners in the G20, and notably the US, to achieve ambitious solutions to the practical issues related to making the requirement operational. This involves, in particular, defining which contracts can be regarded as standardised for central clearing. While standardised contracts should become the norm, non-standardised contracts should also be subject to more in-depth oversight by supervisors.
4. OPERATIONAL RISK
Operational risk relates to losses resulting from inadequate or failed internal processes, or from external events, and includes legal risk. The market has been making efforts to reduce operational risk. For example, market practice has generated standard legal documentation for a considerable part of the derivatives market. Moreover, market participants have gradually moved to electronic processing of trades. These ongoing efforts are likely to be boosted by the mandatory use of data repositories and the widening use of central clearing. These efforts will result in more standardisation of contracts in terms of electronic processing and standard legal terms (without affecting the economic terms of the contracts), which will also facilitate central clearing.
However, the Commission considers that ongoing industry efforts to reduce operational risks should be reinforced. Therefore the Commission intends to assess whether to re-shape the operational risk approach in the CRD in order to prompt standardisation of contracts and electronic processing.
In addition, more collective action is needed by market participants. Therefore, the Commission will further build on the success of the Derivatives Working Group and set ambitious European targets, with strict deadlines, for legal- and process-standardisation, while ensuring that global efforts take due account of European specificities so as to deliver full benefits also in Europe.
5. TRANSPARENCY
OTC derivatives markets have clearly suffered from a lack of transparency of prices, transactions and positions. The lack of transparency to regulators and the market has varied with time and across products, but has overall hindered regulators from efficiently supervising derivatives markets in terms of systemic risk and market abuse. For market participants, it has created difficulties in accessing reliable prices, assessing risks, valuing positions, and checking best execution.
5.1. Trade repositories
Systemic risk and financial regulators need to have a complete overview of the derivatives market. It should therefore become mandatory to report all transactions to trade repositories. Information on trades made on-exchange or cleared through a CCP can be provided to regulators directly by these entities. The Commission will propose legislation governing trade repositories as well as new reporting obligations on market participants.
Repositories will play a central role in the new market structure. They should therefore be regulated in order to ensure that they are operated in a safe, sound and efficient manner. Legislation should provide a common legal framework for the operation of trade repositories and should cover, inter alia, authorisation/registration requirements, access and participation to a repository, disclosure of data, data quality and timeliness, access to data, safeguarding of data, legal certainty of registered contracts, governance and operational reliability[8].
The Commission believes that ESMA should be responsible for authorising and supervising trade repositories, as repositories provide their services on a European, if not global, basis. ESMA should also be responsible for authorising the operation of third-country repositories in the EU on the basis of a Commission decision on the equivalence of the regulatory framework in question, based on prudential concerns. On a reciprocal basis, ESMA should ensure that European regulators have unfettered access to complete global information. In the absence of such access, the Commission would encourage the creation and operation of European-based trade repositories. Ultimately, therefore, ESMA will act as a gateway for disseminating information on derivatives to national financial services regulators as well as sectoral regulators[9].
5.2. Trading on organised markets
The G20 agreed that "all standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate." In the EU, this implies ensuring that eligible trades for exchange-trading take place on organised trading venues, as defined by MiFID[10]. Almost all derivatives exchanges use a central counterparty. Adding exchange-trading to central clearing would eliminate the bilateral nature of concluding trades, resulting in highly visible prices, volumes and open interest, and facilitate market access.
5.3. Pre- and post-trade transparency
Trading on organised venues will need to be accompanied by a strengthening of the provisions applicable to such venues, notably as regards transparency of trading. Harmonising pre- and post-trade transparency requirements for the publication of trades and associated prices and volumes across the various organised venues needs to be carefully considered, also in the case of OTC markets. It will be key to avoid loopholes in the framework of trading venues, and to ensure derivatives are fully covered. This will be addressed within the review of MiFID in 2010.
The increased transparency obligations will need to be measured so as to mitigate any excessive negative side-effects on liquidity and disproportionate administrative costs.
In addition, in Pittsburgh the G20 leaders have agreed "to improve the regulation, functioning, and transparency of financial and commodity markets to address excessive commodity price volatility." Financial regulation will be amended, as part of efforts to ensure that EU agriculture derivatives markets keep their initial purpose of price discovery and hedging as tools to cope with price volatility[11]. These measures will be introduced in parallel with transparency requirements for all derivative (and possibly also other non-equity) markets, namely as part of the MiFID review.
In EU electricity and gas markets, in 2010 the Commission will, as a component of a comprehensive market integrity package, bring forth proposals to ensure the publication of wholesale trades also in spot markets, in order to improve price discovery, market access and overall public confidence[12].
6. MARKET INTEGRITY AND OVERSIGHT
In line with the G20 conclusions, various measures are already underway in the EU towards enhancing market integrity in derivatives markets.
The review of the Market Abuse Directive in 2010 will extend relevant provisions in order to cover derivatives markets in a comprehensive fashion. European securities regulators are advancing with requiring transaction reports in OTC derivatives. In the context of efforts to align the rules applicable to physical and financial energy markets, a tailor-made proposal for the EU level oversight of electricity and gas spot markets is foreseen ensuring transparency and market integrity. Similarly, the Commission is to examine by end-2010 whether the market for emission allowances is sufficiently protected from insider dealing and market manipulation and, if appropriate, bring forward proposals to ensure it[13]. Moreover, in the field of agriculture, more complete transaction and position reporting to financial regulators of derivatives trading activity is foreseen.
The MiFID review will also conclude the work on exemptions for certain commercial firms dealing in commodity derivatives. MiFID provisions including authorisation and operational requirements, reporting and conduct of business rules do not apply to such firms. Findings from consultations[14], and recent developments calling for financial markets regulation to cover all relevant participants, will be taken into account when reaching conclusions.
Finally, the Commission intends to propose rules to give regulators the possibility to set position limits to counter disproportionate price movements or concentrations of speculative positions[15].
7. SUMMARY
The Commission believes that these actions will achieve a paradigm shift away from the traditional view that derivatives are financial instruments for professional use, for which light-handed regulation was thought sufficient, towards an approach where risks are priced properly. The general approach will limit the potential for loopholes and regulatory arbitrage.
The table below summarises the concrete policy actions outlined above. The Commission will now start the process of drafting legislation, notably by launching impact assessments, in order to come forward with ambitious legislation to regulate derivatives in 2010. When finalising these proposals, the Commission will work closely with all stakeholders in the EU as well as with its global partners. It is only by acting together that we lay the foundation for truly efficient, safe and sound derivatives markets.
Future policy actions for ensuring efficient, safe and sound derivatives markets
Objective | Proposed actions | Time line |
Reduce counterparty credit risk - strengthen clearing | Propose legislation on CCP requirements, governing: safety requirements (e.g. conduct of business, governance, risk management, legal protection of collateral and positions) authorisation/withdrawal of authorisation and supervision of CCP mandating of CCP clearing of standardised derivatives Amend CRD in order to: Mandate financial firms supplying initial and variation margin; Substantially differentiate capital charges between CCP-cleared and non-CCP cleared contracts in CRD; | Mid 2010 End-2010 |
Reduce operational risks - standardisation | Assess whether to re-shape the operational risk approach in the CRD to prompt standardisation of contracts and electronic processing. Work with industry to increase standardisation of legal regimes and processes; | End 2010 On-going |
Increase transparency - trade repositories | Propose legislation on trade repositories: Regulate trade repositories Mandate reporting of OTC derivatives transactions to trade repositories; | Mid-2010 |
Increase transparency – trading | Amend MiFID to require transaction and position reporting to be developed in conjunction with CCPs and trade repositories; Ensure trading of standardised contracts on organised trading venues under MiFID; Enhanced trade and price transparency across venues and OTC markets, as appropriate, in MiFID; Conclude review of exemptions from MiFID for commodity firms. | End-2010 |
Improve market integrity | Extend MAD to OTC derivatives; Give regulators the power to set position limits in MiFID. | End-2010 |
[1] Commission Communication "Ensuring efficient, safe and sound derivatives markets" - COM(2009) 332, Staff Working Paper SEC(2009) 905, and Consultation document SEC(2009) 914.
[2] The replies to the consultation, the summary of stakeholder views as well as a summary of the conference and presentations can be found on the Commission's webpage:http://ec.europa.eu/internal_market/consultations/2009/derivatives_en.htm
[3] Commission Press Release "Major step towards financial stability: European market for credit default swaps becomes safer", IP/09/1215, 31 July 2009.
[4] "All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements. We ask the FSB and its relevant members to assess regularly implementation and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse."
[5] So far, the only piece of Community legislation covering the safety and soundness of CCPs is the Settlement Finality Directive (SFD). While essential, as it covers the effects of a default of a CCP participant from spreading to other participants, the SFD is a crisis management instrument, not a broad instrument covering all aspects of CCPs' activities and it is accordingly insufficient to ensure their safety and soundness.
[6] European System of Central Banks and Committee of European Securities Regulators, respectively.
[7] Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 relating to the taking up and pursuit of the business of credit institutions (OJ L 177, 30.6.2006, p. 1).
[8] An initiative aiming for this goal has been launched by the OTC Derivatives Regulators Forum.
[9] In certain commodity derivatives markets (e.g. electricity and gas) there are particular needs to look at the interdependence between spot and derivatives markets. ESMA's ultimate function as a gateway will ensure that repositories have one main regulator, which is important for efficiency. This will also ensure that sectoral regulators will have a convenient access point to information they need. Since the prime purpose of mandating trade repositories is financial stability, oversight structures for commodity spot markets may be designed differently.
[10] Regulated Market, Multilateral Trading Facility, or Systematic Internaliser.
[11] The Commission intends to further address these issues in the forthcoming Communication on a better functioning food supply chain in Europe.
[12] In January 2009, the Committee of European Securities Regulators (CESR) and the European Regulators' Group for Electricity and Gas (ERGEG) recommended to the Commission to develop specific trade transparency arrangements for electricity and gas trading as part of efforts to improve market access and price discovery.
[13] Article 12(1a) of Directive 2003/87/EC as amended.
[14] See for example, advice of the Committee of European Banking Supervisors and Committee of European Securities Regulators (http://www.cesr.eu/index.php?docid=5306) and the European Securities Markets Expert Group(http://ec.europa.eu/internal_market/securities/docs/esme/commodity_derivatives_en.pdf)
[15] This is particularly relevant for commodity markets. See e.g. footnote 11.