Banks to fail in bid for derivatives exemption

Europe’s banking industry will be disappointed in its attempt to secure an exemption from part of the upcoming legislation on derivatives, according to European Commission officials. 

Banks have been seeking a partial exemption from planned rules on clearing of derivatives trades, to match the concessions envisaged for non-financial firms. But the Commission is not willing to extend the exemption to the banking sector.

The European Banking Federation (EBF) had called on the Commission to assess the merits of broadening the exemption, which eases the obligations on some firms to pass their derivatives trades through clearing houses. It said easing the obligations on financial firms would be “balanced and proportional to the actual risks of the counter-parties”.

The Commission plans to present draft legislation on 15 September to regulate the EU’s market for derivatives that are traded over the counter (ie, not on exchanges). A core element of the proposal will be a requirement that derivatives trades should go through central counter-party clearing, a process in which a clearing house acts as a seller to every buyer and a buyer to every seller, with market participants required to pay fees and to lodge money to cover risks.

Trading in over-the-counter derivatives, such as credit-default swaps, is blamed for exacerbating the financial crisis. Central clearing is seen by governments and regulators as a way to reduce the systemic risk that such trading poses to the market. The Commission intends to require clearing for most types of derivatives that are traded over the counter.

Non-financial firms have successfully argued that, because they use derivatives to hedge legitimate risks to their business, and because the size of their trading is not usually systemically important, they should be given an exemption from the clearing requirement. The Commission has responded by planning a financial threshold below which non-financial firms’ trades would be exempt from the obligation. In addition, all trades by non-financial firms that are evidently used to hedge commercial risks will be exempted regardless of their size.

The EBF had argued that “the threshold system could be applicable to financial and non-financial counter-parties alike”, as “an exemption could be granted to financial counter-parties that take positions below what can be considered as systemically relevant”.

But Commission officials said that no such step was planned, as it threatened the objective of bringing transparency to the market.

Regulating the market

Banks are also likely to fail in their attempts to weaken the role of the European Securities and Markets Authority (ESMA) in regulating this aspect of the derivatives market. ESMA will have powers to decide which types of derivatives must be cleared.

The EBF wanted ESMA to have authority only in cases where a clearing house requests clarification. The Commission, however, believes that ESMA must be able to take such decisions on its own initiative.