EC unveils plans to strengthen OTC derivatives market

The European Commission (EC) has released its long-awaited guidelines on reducing risk in Europe’s over-the-counter (OTC) derivatives markets.
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The European Commission (EC) has released its long-awaited guidelines on reducing risk in Europe’s over-the-counter (OTC) derivatives markets.

The commission has launched a public consultation on the guidelines, which closes on 31 August, and will present the results in a public hearing on 25 September. It will then publish conclusions before the end of its current mandate on 31 October and present initiatives, including legislative proposals where justified, before the end of the year.

In the document released today, the commission outlines four ‘tools’ to ensure that OTC derivatives do not harm financial stability. The first is standardisation of derivatives, which the EC contends would enhance operational efficiency and reduce operational risks through broader take-up of standard contracts, electronic trading affirmation and confirmation, central storage, automation of payments and collateral management processes.

The second tool is central data repositories that collect such data as the number of transactions and the size of outstanding positions. The EC cites the Trade Information Warehouse operated by US post-trade utility The Depository Trust & Clearing Corporation as an example, and argues such a repository would increase transparency, knowledge and operational efficiency.

The third recommendation is for a central counterparty (CCP) clearing for derivatives. The industry has committed to achieving CCP clearing of credit default swaps by 31 July. If it fails to deliver, the commission will consider other ways to incentivise the use of CCPs.

The fourth tool is trade execution of OTC derivatives on public trading venues. The EC argues this would improve price transparency and strengthen risk management, but it acknowledges this would come at the expense of satisfying the industry’s diverse trading and risk management needs. The commission will therefore examine how to achieve a more transparent and efficient trading process for OTC derivatives. In particular it will assess the channelling of further trade flow through “transparent and efficient” venues and the appropriate level of transparency for the variety of trading venues.

The industry has broadly welcomed the EC’s document. “The proposals highlight the important role for multilateral trading facilities (MTFs) to provide efficient electronic trade execution, affirmation and confirmation to our customers and full transaction reporting to central data repositories. For standardised products this will improve the efficiency of these vitally important markets,” said UK inter-dealer broker ICAP.

European derivatives exchange Eurex added, “We regard the ways outlined in the commission’s communication both as appropriate and effective to strengthen the safety and integrity of derivatives markets.”