Friday, November 23, 2012

Chancellor Osborne Says UK Vickers-Based Legislation Should Allow Ring-Fenced Banks to Trade Plain Vanilla Derivatives

Chancellor of the Exchequer George Osborne told the UK Parliamentary Commission on Independent Banking Standards that a ring-fenced retail bank should be able to trade plain vanilla derivatives under the proposed legislation implementing the UK's version of the Volcker Rule. Whie derivatives are very complicated and exotic instruments hould not be in a ring-fenced bank, he said, some derivatives are absolutely plain vanilla parts of operating a global economy. In this, the Chancellor disagrees with the Vickers Commission proposals on whikch the    legislation is based.
If you are a farmer who wants to hedge your income or protect yourself against fluctuations in the euro-sterling exchange rate, noted the Chancellor in his testimony, you go to your local branch and buy yourself a derivative. Equally, a small exporter that wants to hedge against the currency risk, will again buy a derivative. He wants to allow these simple derivatives in the ring-fenced bank because the farmer and the exporter will have to pay more for a derivative product if it is not originated by the ring-fenced retail bank.
The legislation  can draw a distinction between simple derivative products and more complex derivative products and trust that judgment to the regulators, The alternative is to say that all derivative products should not be in the ring-fenced bank, which would carry a price. The products are probably more expensive and a small business would not be able to get that product through their retail bank; they would have to start to interact with an investment bank or some other business. Committee members pointed out that it is difficult to define a simple derivative and it might better to keep all derivatives out of the ring-fenced bank. 
While understanding that the Commission is trying to make this all as simple as possible to and does not want any derivative instruments in the ring fence, the Chancellor urged the Commission to look at carefully at the issue, bearing in mind that not all derivatives are the most exotic things that the traders in the City of London and Wall Street are operating with. It is worth exploring if UK legislation an regulation can separate out the more exotic and complex derivatives from the very plain vanilla ones that are used by hundreds of millions of people across the world every day, observed the Chancellor.