OTC regulatory update: consultation (again!) about to start

June 13, 2010

Sometime tomorrow (Monday 14 June 2010) we should have in front of us the latest round of consultation with the European Commission on the regulatory proposals for derivatives.  This is essentially good news, insofar as we expect the wording to be quite explicit about the extent to which non financial companies, as end users of derivatives, will not be subject to anything like the full and misguided force of the original proposals on both sides of the Atlantic.

To get us to this point the EACT and a number of European companies have been very active in seeking to influence the eventual shape of the regulatory proposals.  Meetings have taken place with the DG Markt team in the European Commission, with MEPs (including a formal session at a meeting of ECON), the Barnier Cabinet and Permanent Representatives of member states.  All of this has been supported by national treasury associations’ and individual companies’ discussions with regulators, government bodies and trade associations.

With the launch of the next consultation we are at a crucial stage in the process  Over this weekend I’ve therefore been in contact with the 160+ companies that signed the letter we wrote in early January to the EU Commissioners, stressing the following:

1)            Tomorrow’s consultation will be the final one on the content of the proposed Regulation (not a Directive).

2)        It is expected that the consultation (which will be open for four weeks) will see DG Markt seek views on a limited number of policy issues but the document is likely to make clear the intention to exempt (or, exclude from regulatory scope) the derivative transactions of non-financial end users engaged in risk mitigation.  That said, we are well aware of two major issues for the Commission: firstly, the fear that ‘exemption’ creates loopholes for some businesses in the financial sector and elsewhere; and secondly that some non-financial end users are a source of systemic risk in their use of derivatives and should therefore not enjoy exemption.

We have argued extensively that this latter argument is unsustainable.  Nonetheless in order to address these two issues the Commission will propose two ‘threshold levels’ – one qualitative and the other quantitative; the latter (higher) level will if breached create a requirement to pass derivatives through central clearing.  A major issue in the consultation will therefore be around the working of the thresholds and the responsibility for their implementation (likely to assume the involvement of the new European regulatory body, ESMA).

3)        The ‘elephant in the room’, as we anticipate a good outcome in terms of exemption for non-financial end users, is of course the risk that the future Basel III capital requirements regime is actively used to drive non centrally cleared OTC transactions into central clearing.  The EACT and others have been actively flagging this unhelpful and illogical consequence; although there is a long way to go my personal view is that we are not alone in recognising the issue.

4)        The EACT will co-ordinate the drafting of a response to the Commission’s consultation.  It will then be vital that in addition to the EACT as many companies (and national treasury associations) as possible make their own submission to the Commission; we can share the EACT’s drafting but it is most important that something a little more than a simple cut and paste is undertaken.  The same encouragement of course extends to national organisations that individually may be open to persuasion to make a response.

5)        In order to have more professional expertise in our efforts to influence the European Union outcome on derivatives regulation a number of companies, together with some national treasury associations, have committed financial support to pay for an external advisor.  That work has now been commissioned in the name of the EACT and is underway.  The EACT would welcome additional financial support from like-minded companies!

6)            Finally, we will aim to repeat the letter to the EU Commissioners with a similar or larger number of signatories – almost certainly to coincide with the end of the consultation.

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