FSB in call for quick reform on derivatives

Tim Wallace
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DERIVATIVES market reforms are proceeding too slowly in the EU, according to a Financial Stability Board (FSB) report out yesterday.

“Aggressive” action is needed to meet the G20’s deadline of the end of 2012, the FSB warned.

The US has been more prompt in enacting legislation to standardise derivatives trading.

Regulators intend to make market participants hold more capital against over-the-counter (OTC) derivatives than exchange traded ones. The plans are particularly important right now as investors and regulators try to work out how much exposure banks have in the derivatives market.

However, the exact level is unclear, as the Basel III requirements on risk exposures to central counterparties (CCPs) are still not settled.

Banks trading non-centrally cleared derivatives will also be subject to an additional “credit valuation adjustment charge” representing potential losses incurred should their counterparties’ credit quality change.

Choosing which derivatives to move onto exchanges can be problematic.

The report recognised the importance of carefully defining the relevant characteristics, to cover new derivatives and protect niche products.

For example, exchange-based trading is only feasible for derivative in sufficiently liquid markets – and the report explained that current methods “do not give the authorities sufficient information on liquidity”.

The level of transparency in the market is also yet to be decided. EU proposals would see pre-trade prices and volumes published for all trades, whilst Dodd-Frank negotiations on these requirements in the US are still ongoing. Post-trade, they will be published in both major jurisdictions.

The reforms will be costly for market participants, though the EU intends to exempt pension funds from new rules “to avoid likely negative impact on future pensioners’ income.”