EU regulators wary lest reforms drain liquidity

Wed Feb 8, 2012 11:57am EST

* Regulators studying collateral vs liquidity trade off

* Regulators see push for segregated accounts for margins

* EU's ESMA say some rulemaking deadlines now unrealistic

* ESMA says new EU trading rules must be tailored to markets

By Huw Jones

LONDON, Feb 8 (Reuters) - A welter of new financial rules may need to be phased in and more finely tailored to avoid draining too much liquidity from markets and the wider economy, European regulators said on Wednesday.

The European Union is introducing rules from this year to curb shortselling, regulate derivatives and reshape off-exchange trading, all of which will force banks to rethink their business models.

One aim is to make trades less risky by backing them with collateral such as government bonds and cash.

But with many government bonds suffering from lower credit ratings and cash scarce, banks and regulators worry too much top quality liquidity could be tied up in collateral rather than being put to use in economies and spurring growth.

"We are very conscious of potential liquidity implications," said Barry King, senior associate for OTC derivatives policy at the UK's Financial Services Authority.

The FSA and other regulators from around the world have set up a working group to study whether making it mandatory for both sides of a trade to post initial margins would generate too much of a drain on liquidity, King said.

Regulators are also looking at the extent to which collateral should be segregated so that it cannot be used for other purposes. Pension funds want to move towards individual segregated margin accounts at clearing houses, King said.

"The first priority has to be financial stability and achieve it in a way that maintains liquidity wherever possible. I don't think this is being overdone," King told an Association for Financial Markets in Europe banking lobby conference.

There is a real risk that there won't be sufficient time for markets to adjust, and some of the reforms may need to be introduced in a staged process, King said.

TAILORING

Next Monday the European Parliament kicks off the approval process for a sweeping update of market rules governing such as things as trading in off-exchange derivatives, a draft law dubbed MiFID II.

The current MiFID rules opened up share trading to fierce competition with strict transparency rules, but banks fear the lawmakers will try to impose this model onto other markets including bonds and derivatives.

Simon Maisey, a managing director at bank JP Morgan said there were dangers to imposing one particular market structure on another.

"It's pretty well understood now the difference between fixed income and equities," Maisey said. Markets have evolved over many years, and introducing a step change overnight risks destroying their liquidity, he added.

Steven Maijoor, chairman of the European Securities and Markets Authority, which will flesh out implementing measures for MiFID II, offered some reassurance.

"The calibration of transparency regimes has to be undertaken per asset class and in many cases per type of instrument within each asset class so as to avoid that transparency harms liquidity," Maijoor told the conference.

"Hence, we should not opt for a mechnical extension of the MiFID equity transparency requirements to non-equity financial instruments," he said.

It was not only banks that need more time to adjust to the new rules, ESMA and other regulators themselves needed more time to agree them in the first place, Maijoor said.

The deadlines to agree implementing measures for the new EU short-selling law "are too short", and the end-2012 deadline for new derivatives rules was "challenging", he said.

"We are clearly not at cruising speed. We need more people to do the work," Maijoor added.

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