Achieving meaningful and lasting reform in OTC derivatives

Published 21/10/2010

Derivatives play a vital role in managing risk for financial institutions, investors and non-financial corporates. Both exchange-traded and OTC derivatives have a clear social and economic benefit. Europe accounts for more than half of all global OTC derivatives activity, and is home to several major derivatives exchanges. Taken alone, the UK is the world’s largest OTC derivatives trading centre. Derivatives are an important contributor to the economies of the EU.Financial reform following the credit crisis is an essential process that market participants recognise as important and necessary. Regulatory change should address the true causes of systemic fragility and avoid erecting unnecessary barriers within competitive financial markets.

This paper, produced in response to the European Commission consultation on OTC derivatives, underlines the following policy objectives:

  • EU legislation for OTC derivatives reform should remain focused on the core policy goals of systemic and operational risk reduction. European policymakers should ensure that:
  • legislation is tailored to each product segment and market, to ensure that
  • benefits to systemic risk outweigh any negative market impacts.
  • legislation does not unduly harm the competitive environment under which Europe has fostered innovation and nurtured the world’s largest OTC derivative centre.
  • the market remains user-friendly. Investors’ interests should be considered explicitly in discussions on systemic risk reduction and operational efficiency measures.
  • Recognising the cross-border nature of financial markets, infrastructure providers should be allowed to compete on even terms regardless of location within the EU, while maintaining a high level of risk management standards.
  • To liaise closely with US regulators and legislators to ensure a globally coherent approach.
  • To ensure that regulation of the FX market remains focused on settlement risk – the dominant systemic risk. Any proposal to apply the mandatory clearing obligation to FX derivatives would have to be carefully analysed to ensure there are no negative impacts on the operation of CLS or, more generally, for Europe and the UK given the latter’s importance as the world’s largest FX market centre.
  • To ensure that disadvantages of increased transparency are recognised and weighed up against the benefits. Specifically, pre- and post-trade transparency should not be introduced inappropriately to OTC derivatives markets, to the detriment of market liquidity.