CHAPTER 6: Summary of Conclusions
129. We recommend that the Government should
invite the Commission to explain in detail which contracts will
be covered by the definition of derivatives used in its proposed
regulation, and clarify the scope of, and exemptions from, the
regulation (para 14).
Derivatives: benefits and risks
130. Derivatives have sound economic and commercial
benefits, and have been and remain necessary to the development
of trade and commerce, but the manner in which they are used can
pose a risk to the system (para 27).
131. Derivatives have an important economic function,
namely redistribution of risk, but some forms of derivatives can
be used as tools for speculation by participants in the financial
market who have ownership of the underlying asset. Coupled with
a lack of transparency in the market, where build-ups in risk
cannot be detected by actors or supervisors, derivatives could
help destabilise the financial system, particularly if there is
a significant shift in the value of underlying assets (para 40).
Trade repositories
132. We agree with the future policy actions
suggested by the Commission to increase transparency in the OTC
derivative markets by supporting the use of trade repositories
to record OTC derivatives contracts to ensure all trades in the
market are reported. Trade repositories should enhance market
transparency for regulators and reduce systemic risk by ensuring
that supervisors have a comprehensive picture of market concentrations
and exposure within a given asset class and allow supervisors
to more accurately identify the misuse of derivatives. Further
consideration should be given to access to data held by trade
repositories (para 50).
133. Whilst the regulatory framework for trade
repositories should be at the EU level and reflect globally agreed
standards, further consideration should be given to the appropriate
level of supervision within the EU (para 57).
Standardisation and central counterparty clearing
of OTC derivatives contracts
134. We welcome Commission and industry efforts
to encourage standardisation in derivatives products. We agree
with the Government and the Commission that standardised contracts
can help improve transparency and stability in the OTC derivatives
markets. However we note that not all products can be standardised
and that room must be left, in an efficient market, for bespoke
derivatives that meet the specific needs of corporates (para 62).
135. We welcome the approach of the Commission
in looking at ways to increase the proportion of contracts centrally
cleared in order to reduce systemic risk. However, as the Commission
recognises, central clearing is not a feasible option for all
investors and all contracts. Increased use of CCPs should increase
transparency in the sector by providing centralised locations
for data on overall market positions, by ensuring that all derivatives
contracts are reported and by enabling a clearer view of the total
net amount owed on derivatives contracts (para 74).
136. We agree that standardisation should not
lead to compulsory CCP clearing eligibility. Similarly, a lack
of standardisation should not necessarily indicate clearing ineligibility
(para 83).
137. The Government should encourage the Commission
to define carefully in the final proposal which contracts should
be regarded as both standardised and appropriate for central clearing.
CCPs should not be allowed to clear a product if they are not
prepared to manage the risk. CCPs are privately owned companies,
which can currently refuse to clear products where they feel they
cannot manage the associated risk and this system has worked well
even during the financial crisis (para 84).
138. Increased standardisation and central clearing
of OTC derivatives can increase transparency and stability. However,
not all products, nor all standardised products, are suitable
for central clearing. Legislation should avoid forcing these products
through central clearing as this may increase risk in the system
if a CCP cannot effectively manage the risk associated with a
product (para 90).
139. It is important that bespoke products are
appropriately risk-managed though the use of capital charges proportionate
to risk. The Government may wish to encourage the Commission to
impose proportionate levels of capital charges in connection with
the trading of non-standardised derivatives. Disproportionate
levels of capital charges for non-standardised derivatives could
discourage innovation or, at worst, force products through central
clearing which are both destabilising to, and unsuitable for,
CCPs (para 97).
140. Non-financial businesses use derivatives
for the purpose of risk management but these derivatives are inherently
less risky as they are closely related to underlying assets. The
Commission proposals could have the effect of adversely penalising
the use of this type of derivative. We welcome the Commission's
confirmation that the effect any proposals would have on non-financial
end-users of derivatives will be considered in the Impact Assessment
(para 104).
The EU regulation of CCP clearing houses
141. We welcome the Commission's acknowledgement
of the need to develop a coordinated global approach in line with
the work of CPSS and IOSCO. We also recommend that the Commission's
Impact Assessment should examine in detail where minimum standards
are appropriate and whether specific calculations on risk and
margins are best left to the clearing house itself (para 113).
142. We recognise that the absence of any cross-border
fiscal burden-sharing arrangements for failing financial institutions
means that supervision of CCPs at EU level is probably unrealistic.
It may be appropriate to develop a supervisory system at EU level
along the lines of that currently under negotiation for EU banking
supervision, in which supervisory best practice is shared and
technical standards defined (para 117).
143. The separation of collateral from clearing
houses' other assets can help maintain liquidity in a crisis.
We agree with the Commission that proposals to include specific
requirements for separation of assets are attractive (para 120).
144. Supervision will be more effective if it
ensures that CCPs compete on quality of service, rather than size
of margins (para 124).
145. Increasing the role of CCPs in the derivatives
market increases their effect on market stability. If the number
of CCPs operating in Europe falls in the future, as predicted
by witnesses, this will also have the effect of increasing the
systemic importance of the CCPs that remain. We agree with the
Minister that this reinforces the importance of effective regulation
and supervision of CCPs (para 128).
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