After the big sleep, Brussels is alive and leaking

September 8, 2010

I’m ‘grounded’ again, by which I mean my feet are back on earth – after going into a personal orbit in response to the lamentable (ignorant, unfounded) editorial in the Financial Times last Friday. The FT had the decency to print my rebuttal letter on Monday and there perhaps matters rest.

Dealing with Brussels on regulatory policy continues to be a fascinating experience. We had the big sleep of August: everyone in continental Europe seemed to have left for the beach; work came to a sudden and complete halt. No sooner was August almost ended – with early adopters returning to their desks in Brussels and Paris – than we have had a major leak….. The leak of the draft regulation on derivatives has been so comprehensive that Brussels seems to be awash with the document, which is officially published on 15 September.

We at the EACT have been in extensive discussions about the draft. There is largely good news, in that there is very explicit recognition of the need for a wide exemption of derivative contracts entered into by ‘non-financial counterparties’ provided these are ‘objectively measurable as directly linked to the commercial activity of that counterparty’. The exemption is from the calculation of positions relative to the two thresholds (information and clearing), with these thresholds an integral part of the European Commission’s approach. Our submission in response to the last round of consultation with the European Commission had argued that there should be one threshold only, and that the more radical clearing threshold was unworkable in practice and unnecessary to achieve the regulatory objectives. However we believe that the approach now being proposed can be made to work.

There are many aspects of the regulation that require detailed work and where – assuming that the overall approach remains intact as it passes through Parliament and Council – it will be vital that the high level principles in the draft are not compromised to the detriment of risk mitigation by non-financial companies. There is plenty of scope for that, not the least because there are key details needed on the practical operation of the thresholds: how will outstanding contracts be treated if a threshold is passed – in either direction; what exactly will be the position of the financial counterparty in a contract that falls below the threshold; what will be the measurement bases for the thresholds?

The detailed implementation of the regulation will be in the hands of ESMA, the European securities regulator, which will work with the newly established European Systemic Risk Board, the ESRB. The timescales that I am hearing extend over two years, so the story is by no means over. And of course there is another plotline here – the uncertainty overt the outcome on Basel III. The threat remains that punitive capital charges will undo the benefits of the exemption that we appear to have obtained on the regulatory front. And so it goes on!

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