Over-the-counter products are to be subject to a raft of new regulations designed to increase stability and reduce systemic risks
The European Commission has unveiled strict new rules to regulate derivatives.
Under the new regime over-the-counter derivatives will need to be reported to regulatory offices known as trade repositories. The trade repositories will publish aggregate positions by class of derivatives to reveal overall market positions.
Currently there is no requirement to report OTC trades. The Commission regards this lack of reporting as a serious problem, as regulators have no idea what deals have been transacted, and therefore no knowledge of any systemic risks.
OTC derivatives are contracts between private parties, as contrasted with exchange traded derivatives, which are, as the name suggests, traded on an exchange. OTC derivative contracts are often cleared through a third party, known as a central counterparty. The Commission is proposing that all standard OTC derivatives are cleared this way, to reduce counterparty risk.
The Commission announced rules designed to reduce counter-party risk will impose capital requirements on market participants, plus a range of procedural requirements for trading derivatives. Transaction terms will need to be communicated electronically to increase transparency.
The new measures are part of an overhaul of the Markets in Financial Instruments Directive, or MiFID.
Michel Barnier, commissioner for the internal market, said: “No financial market can afford to remain a Wild West territory. OTC derivatives have a big impact on the real economy: from mortgages to food prices. The absence of any regulatory framework for OTC derivatives contributed to the financial crisis and the tremendous consequences we are all suffering from. Today, we are proposing rules which will bring more transparency and responsibility to derivatives markets. So we know who is doing what, and who owes what to whom. As well as taking action so that single failures do not destabilise the whole financial system, as was the case with Lehman’s collapse.”
The Commission has also unveiled plans to expand other derivatives regulations including:
- Revision of the Capital Requirements Directive (e.g. differentiation of capital charges between CCP cleared and non-CCP cleared contracts)
- The Market Abuse Directive (extending the scope of the Directive to OTC derivatives).
The current proposals have been passed by the Commission to the European Parliament. According to an agreed timeline the new rules must be in place by the end of 2012.
Non-financial organisations which use OTC derivatives, such as farms and manufacturers, will be exempted from the new rules.