Derivatives market braced for regulatory skirmishes

* Derivatives sector sees regulatory grey areas

* EU watchdog says some cross-border overlap inevitable

* Top derivatives official says industry ready for changes

By Huw Jones

LONDON, Sept 20 (Reuters) - Regulators could end up with a "trade war" on their hands if they don't align their rules to make derivatives markets safer, the sector's leading body said on Thursday.

Laws to channel swathes of the $650 trillion privately traded derivatives market on to electronic platforms and clearing houses to manage risks better are being phased in during 2013.

Banks that account for most derivatives trading, which is mainly based in London and New York, fear they will be snared by overlapping rules from the United States, European Union and Asia, creating a costly and bureaucratic headache.

The new rules already mean that the cost of doing business will increase sharply even without such overlaps.

"In extreme, we could face a regulatory trade war," Robert Pickel, chief executive of the International Swaps and Derivatives Association (ISDA) told the industry body's annual conference.

Derivatives were at the heart of the collapse of U.S. bank Lehman Brothers four years ago, causing a near meltdown in global markets and prompting the G20 nations to agree a welter of reforms, including higher bank capital buffers.

ISDA is the top derivatives industry body representing participants dealing in contracts such as interest rate swaps, credit default swaps and commodity derivatives.

Pickel said that a more coordinated effort was needed among regulators, singling out proposed rules from the U.S. Commodity Futures Trading Commission (CFTC).

Regulators in Europe and Asia have complained that the CFTC's planned rules will encroach on their supervisory turf.

"Just how far is the CFTC going to assert its jurisdiction? Very far! The CFTC knows the whole world is watching," Pickel said.

Cross-border fallout from trading scandals and alleged manipulation of the Libor interest rate have put political pressure on regulators to become more assertive globally.

RAISED HACKLES

The U.S. watchdog's chairman Gary Gensler raised hackles in London in June when he said that U.S. firms had sought out "lower regulatory regimes" in places such as London and, when things go wrong, it comes "crashing to our shores".

There is also an emerging tussle among UK, EU and U.S. regulators over how to supervise Libor in future.

Failure to avoid such "extra-territoriality" will fragment derivatives markets and create systemic risk by creating uncertainties such as what happens when a contract must be cleared in one country but not another, Pickel said.

Duplicated reporting of trades would backfire on supervisors by making it harder for them to have a clear picture of who owns which position, he added.

The new derivatives rules for the EU will be rolled out by the European Securities Markets Authority (ESMA), which is due to publish them next week.

Rodrigo Buenaventura, ESMA's head of markets, said that some international overlapping was inevitable and justified, but the vast majority of EU and U.S. rules would be aligned.

"You have to have instruments to avoid provisions under the regime being evaded through third-country subsidiaries," Buenaventura told the conference.

"I am not so worried about whether there is some cross-border reach. I am more worried about two sets of rules for the same firms. I hope there is still a chance of getting to a closer understanding among the regulators."

ISDA Chairman Stephen O'Connor, who is also managing director of Morgan Stanley, said that the derivatives market will change for ever, but he rejected accusations that the trade body was all about pushing back on new rules.

"We are in unchartered waters," he said. "This autumn marks significant changes in how we do business ... Yes, broadly speaking, the industry will be ready."