Bloomberg News

Global Rules to Cut Derivatives Risk May Miss Deadline, FSB Says

October 11, 2011

Oct. 12 (Bloomberg) -- Global rules for trading of over- the-counter derivatives risk being implemented behind schedule and in an inconsistent way that weakens their effectiveness, the Financial Stability Board said.

Some Group of 20 nations may miss an end-2012 deadline for implementing the rules, putting at risk the resilience of the global economy to dangers stemming from defaults on derivatives trades, the FSB said. Gaps include failure to put in place measures to push trades through clearinghouses and making trading systems more transparent.

“Consistency in implementation across jurisdictions is critical” to reduce the risk that this trading could cause another financial crisis, the FSB said in a progress report published on its website yesterday.

Regulators sought new rules for OTC derivatives following following the collapse in 2008 of Lehman Brothers Holdings Inc. and the rescue of American International Group Inc., two of the largest traders in credit default swaps.

In addition to the clearing and transparency rules, the plans also include forcing banks and other firms to hold more capital to guard again losses, and pushing traders to use exchanges and other recognized trading venues.

Japan and the U.S. are so far “the only jurisdictions that have adopted legislation mandating central clearing” of standard types of OTC derivatives, the FSB said.

“Many jurisdictions,” have indicated that they will press ahead with rules once the U.S. and 27-nation European Union has put in place measures.

‘Aggressively Push’

Nations should “aggressively push” to meet the end-2012 deadline “in as many reform areas as possible,” the FSB said. Canada, Hong Kong, India, Mexico, South Korea and Russia, are among the countries that may miss the implementation date unless they take further steps, the board said.

There is also a risk that traders may get round the requirements unless nations ensure that they also apply to trading that is moved from the OTC market onto exchanges and other organized venues, the FSB said.

Nations are facing “implementation challenges” due in part to the “complexity of needed laws and regulations,” the board said.

“The FSB has been aware from the outset that there is a risk that overlaps, gaps or conflicts in legislative and regulatory frameworks, if not addressed, could compromise achievement of the G-20 objectives,” the board said in its report.

‘Regulatory arbitrage’

One risk is that in some nations the clearing and trading rules will cease to apply once the derivatives are traded on exchanges or other platforms, potentially creating “opportunities for regulatory arbitrage” and compromising attempts to “reduce systemic risk,” the FSB said.

Finance ministers from the EU reached an agreement on Oct. 4 on how the rules should apply in the region. The final version of the law will now be hammered out in negotiations with the European Parliament.

The U.K. had threatened to oppose the deal in part because of concerns that the law would not cover trading moved onto exchanges. U.K. Chancellor George Osborne agreed to back the rules after securing an EU declaration that future legislation will further increase the role of central clearing. U.S. Treasury Secretary Timothy F. Geithner has also urged for the EU measures to have a broad scope.

The FSB brings together regulators and finance ministry officials from the G-20, as well as standard-setting bodies such as the Basel Committee on Banking Supervision.

Clearinghouses such as LCH.Clearnet Group Ltd. and Deutsche Boerse AG’s Eurex Clearing operate as central counterparties for every buy and sell order executed by their members, who post collateral, reducing the threat from a trader’s default.

Nations also appear to be taking “divergent approaches” to pushing trading onto organized venues, the FSB said.

The board’s next progress report will be published in early 2012.

--Editors: Peter Chapman, Anthony Aarons

To contact the reporters on this story: Jim Brunsden in Basel at jbrunsden@bloomberg.net;

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net.


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