McCreevy Sees Transatlantic Consensus Building on Legislation Regulating Derivatives

There is a transatlantic consensus building on the contours of legislation regulating derivatives as the US House Financial Services Committe marks up the OTC Derivatives Markets Act and the European Commission reviews over 100 comments on its derivatives regulation proposal. In remarks at a recent derivatives conference in Brussels, Commissioner for the Internal Market Charlie McCreevy said that there is a broad cross-border consensus that standardized OTC derivative products should be cleared as far as possible by central clearinghouses and that central data repositories should enable regulators to get a complete overview of where the risks are in the system. For those segments of the market that may not fit central counterparty clearing because they are too bespoke, he noted, bilateral clearing should be tightened and made more secure.

Heeding the urgent call of Commissioner McCreevy, the derivatives industry has already begun to implement the clearing of credit default swaps on a European central counterparty, pending a more complete review of the whole derivatives area. Two European central counterparty clearing entities, ICE Europe and Eurex, have began clearing credit default swaps in the EU.

The question now is how to expand the use of central counterparties beyond credit default swaps. Chairman McCreevy suggested that the Commission could provide incentives through regulatory capital, or could simply mandate the use of central counterparty clearing. There is also the issue of how central counterparties should be regulated in the single market, bearing in mind their systemic relevance.

A similar question exists regarding the use of central data repositories. For example, should the use of repositories be incentivized or mandated by law, and how should the Commission ensure data quality and also ensure equal access of regulators to the stored data.

Another area the Commission will examine is bilateral clearing: Central counterparty clearing can only cover a subset of the market. Some derivatives are too bespoke to be centrally cleared. If the Commission incentivizes the use of central counterparty clearing, noted Mr. McCreevy, that will make bilateral clearing more costly. Or put more bluntly, bilateral clearing will reflect better the social cost of counterparty risk, which is now partly borne by the taxpayer. One approach might be stricter collateral requirements, said the commissioner, while another could be raising the regulatory capital cost for bilaterally-cleared products. A final concern, and a very important one, is how to incentivize standardization of derivatives without stifling innovation.

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