4 Financial services
(31958)
13917/10
+ ADDs 1-2
COM (10) 484
| Draft Regulation on OTC derivatives, central counterparties and trade repositories
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Legal base | Article 114 TFEU; co-decision; QMV
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Document originated | 15 September 2010
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Deposited in Parliament | 23 September 2010
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Department | HM Treasury
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Basis of consideration | EM of 22 September 2010
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Previous Committee Report | None
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Discussion in Council | Not yet known
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Committee's assessment | Politically important
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Committee's decision | Not cleared; further information requested
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Background
4.1 The financial crisis highlighted deficiencies within the over-the-counter
(OTC) derivatives markets a traditionally opaque part
of the market traded bilaterally between firms rather than over
exchanges. These deficiencies were:
- counterparty risk the web of relationships in the
OTC market means the fear of default of a major market participant
can have systemic implications. The AIG affair highlighted weaknesses
in the management of counterparty risk, when a credit downgrade
required AIG to post collateral it could not afford; and
- transparency the financial crisis, for
example, the failure of Lehman Brothers, demonstrated that market
participants and regulators did not have sufficient visibility
of exposures in the OTC market, causing unwillingness to trade
in stressed markets.
To address these issues the G20 agreed at the Pittsburgh
summit on September 2009:
"To this end, 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."
4.2 The Commission has examined derivatives markets
and their regulation and published in 2009 two Communications
suggesting future policy actions for the regulation of derivatives
markets at EU level. The first Communication, Ensuring efficient,
safe and sound derivatives markets,[14]
presented the findings of an in-depth Commission review of
the derivatives markets and launched a consultation on the regulation
of derivatives markets. The second, Ensuring efficient, safe
and sound derivatives markets: Future policy actions,[15]
outlined "the policy actions the Commission intends to take
in 2010 to ... meet the need for greater stability and transparency
in these markets."
The document
4.3 This draft Regulation would be the main way to
implement in the EU the G20 commitment on OTC derivatives, central
counterparties and trade repositories. The proposal includes
six broad measures:
- requiring central clearing
for OTC derivative trades where appropriate;
- new prudential and organisational standards for
Central Counterparties (CCPs);
- a requirement to report derivative transactions
to trade repositories;
- new arrangements for authorisation and supervision
of CCPs following the creation of the pan-EU regulatory authorities;
- new supervisory arrangements for trade repositories;
and
- a right for CCPs to interoperate in clearing
cash instruments.
4.4 Requiring CCP clearing would make CCPs the counterparty
for all eligible trades and as 'circuit breakers' in the web of
counterparty risk in the event of market stress. The draft Regulation:
- is broad in scope and could
potentially capture all market participants and all forms of OTC
derivatives;
- would, however, give discretion to the European
Securities and Markets Authority to devise rules that would exempt
non-financial, that is corporate, end users of OTC derivatives
where they were hedging commercial risk or were not systemically
significant;
- would have the European Securities and Markets
Authority develop objective criteria for adoption by the Commission
to assess whether obligatory central clearing would be appropriate
for any given OTC derivative product. This process would be initiated
when a national regulator approved a CCP's proposal to clear a
new type of derivative product;
- would require the European Securities and Markets
Authority, with the European Systemic Risk Board, to develop a
list of products, not yet available for central clearing at any
eligible CCP, that should potentially be subject to the clearing
obligation; and
- includes measures to improve the risk management
of derivative transactions that would remain ineligible for central
clearing.
4.5 Given the increased systemic significance of
CCPs that would result from obligatory central clearing, the draft
Regulation provides for new organisational and prudential requirements
for CCPs. The draft Regulation would:
- set out on the prudential side
common standards for the mechanisms that protect a CCP against
failure, notably participation requirements, financial resources,
margin calls and the overall default waterfall; and
- set out organisational requirements to ensure
CCPs have appropriate governance and risk management arrangements.
4.6 The draft Regulation would:
- require market participants
to report the detail of derivative transactions to a trade repository,
in order to address the lack of transparency in the OTC derivatives
market and give regulators better access to appropriate data;
- move responsibility for registration and supervision
of trade repositories from national regulators to the European
Securities and Markets Authority;
- require trade repositories be established in
the EU, although with scope for recognition by the European Securities
and Markets Authority of third country trade repositories that
meet specified stringent requirements;
- set out the relationship between CCPs, national
regulators and the new European Supervisory Authorities;
- provide for national regulators to be the lead
body responsible for authorisation and supervision of CCPs, the
European Securities and Markets Authority to have a central role
in the college of competent authorities responsible for CCP authorisation
decisions and the Authority to facilitate adoption of a joint
opinion in the event of disagreement within the college; and
- give CCPs the right to seek interoperability
arrangements with other CCPs for clearing cash instruments, provided
regulators are satisfied that risks are appropriately managed,
with the aim of reducing the fragmented EU post trading infrastructure.
4.7 The draft Regulation would delegate development
of much of the technical detail to relevant European Supervisory
Authorities, requiring them to submit draft technical standards
to the Commission by 31 December 2012, drawn up in accordance
with the European Supervisory Authorities legislation, which requires
the relevant Authority to consider the costs and benefits and
to consult publicly and the Commission to consult the Council
and the European Parliament.
The Government's view
4.8 The Financial Secretary to the Treasury (Mr Mark
Hoban) says that the Government believes that the draft Regulation
is justified under the principle of subsidiarity because of the
need to have consistent application of the clearing obligation
throughout the EU, as in the G20 agreement. But, noting that the
draft Regulation proposes national supervision of CCPs but supervision
of trade repositories by the relevant European Supervisory Authority,
he adds that in Council working group negotiations the Government
will be keen to ensure that national authorities have a central
role in supervising CCPs and trade repositories.
4.9 On the policy implications of the proposal the
Minister says that:
- the Government fully supports
the implementation of the G20 commitment to increase the safety
of the OTC derivatives market;
- the draft Regulation is a critical element of
the package of regulatory reforms being implemented in response
to the financial crisis, addressing some of the fundamental weaknesses
revealed by it;
- transparency in the OTC derivatives market would
be transformed by the reporting of transactions to trade repositories
and the management of counterparty risk will see a step change
enhancement through obligatory central clearing for appropriate
derivative products; and
- the Government is aware of the potential implications
of concentrating systemic risk within CCPs and the cost of requiring
market participants to hold more collateral against derivative
positions to comply with CCPs risk management requirements.
He continues that, overall, the Government therefore
believes these aims should be achieved in a way that does not
discriminate against UK market participants and infrastructures,
ensures the regulatory burden imposed is proportionate to the
benefit in terms of systemic risk reduction and supports the introduction
of robust prudential standards for CCPs "thus [it]
will be keen to protect the UK position at Working Group."
The Minister adds that it is important that reforms are implemented
consistently across G20 partners to prevent regulatory arbitrage.
4.10 On some of the detail of the draft Regulation
the Minister says that:
- the Government broadly supports
the Commission's proposal, but notes that the impact on market
participants and the resulting reduction in systemic risk will
in large part be determined by the detailed technical rules the
draft Regulation would require the European Securities and Markets
Authority and the European Banking Authority (EBA) to develop
for adoption by the Commission;
- given the inherently prudential nature of much
of the proposal, the Government believes there are good arguments
for a greater involvement of the European Banking Authority in
developing and implementing these rules than the draft Regulation
currently proposes;
- the Government supports assigning the European
Supervisory Authorities responsibility for determining which products
should be subject to the clearing obligation, which is a key part
of this proposal and will be concerned to ensure that the European
Supervisory Authority has the flexibility and expertise to take
these decisions in an appropriate and proportionate way;
- the Government supports the principle in the
proposal that no CCP should be forced to clear a product it is
not comfortable risk managing;
- it supports the proportionate approach suggested
by the Commission for corporate (non-financial) market participants,
but notes that more work will be required by the European Supervisory
Authorities to ensure the detailed implementation of the proposed
thresholds is effective in reducing systemic risk, while not imposing
unnecessary uncertainty and burden on corporate users of OTC derivatives;
- the Government believes there may be a case for
similar flexibility in applying the clearing obligation to financial
firms which do not present a systemic risk;
- it supports the Commission's proposal to give
national regulators the lead role in supervising and authorising
CCPs, given the potential fiscal risk they represent; and
- the Government believes that national authorities
should be responsible for the authorisation and ongoing supervision
of trade repositories.
4.11 The Minister, noting that the Commission's impact
assessment is largely qualitative in nature given the opacity
of the OTC derivative markets, says that the Government broadly
agrees with the conclusion that the costs are likely to
be outweighed by the benefits of market stability brought about
by these proposals. He adds that the exact costs of the proposal
will depend on the scope of products that will ultimately be submitted
to CCP clearing.
4.12 The Minister tells us that the Government has
consulted widely with CCPs, clearing banks and buy-side market
participants and their trade associations as this draft legislation
has been developed.
Conclusion
4.13 We note that, although the Government is
generally supportive of this draft Regulation, there are matters
which it wishes to see addressed during negotiation of the proposal.
So before considering the document further we should like to hear
from the Minister about progress on these matters, including the
potential subsidiarity point he mentioned. We should also like
to hear about the views of those the Government has been consulting
about the draft Regulation. Meanwhile the document remains under
scrutiny.
14 See (30788) 11873/09 + ADDs 1-2: HC 19-xxvi (2008-09),
chapter 7 (10 September 2009) and HC 19-xxxi (2008-09), chapter
13 (11 November 2009). Back
15
See (31055) 15047/09: HC 5-i (2009-10), chapter 22 (19 November
2009). Back
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