UPDATE 1-EU watchdog proposes window to adjust to derivatives clearing

Thu May 8, 2014 8:17am EDT

* Watchdog suggests 8-9 month respite as new rules loom

* Changes aimed at making $700 trillion market safer (Adds more detail, derivatives industry reaction)

By Huw Jones

LONDON, May 8 (Reuters) - Banks should get a breathing space of a few months to adjust to coming new rules on the clearing of derivatives deals, a top European Union regulator proposed on Thursday.

The new rules, designed to make markets safer, will require banks to pass more derivatives transactions in Europe through clearing houses - third parties which are backed by a default fund in case one side of the trade goes bust. Uncleared deals - known as over-the-counter (OTC) - will attract higher charges because of the increased risk.

But the rollout has created legal uncertainty for many banks over 'frontloading' - the risk that contracts they issue now may have to be cleared later, leaving them unsure how to price the deals.

The global derivatives market is worth around $700 trillion, with London and New York the biggest centres.

The European Securities and Markets Authority (ESMA), the watchdog rolling out the new derivatives rules, asked the EU's executive Commission on Thursday to give banks some temporary leeway to avoid legal grey areas.

ESMA Chairman Steven Maijoor said this was needed to avoid bumping up compliance costs, and to stop some market players being tempted not to use derivatives to hedge or insure against risks during the period of uncertainty.

"Given the urgency... an early reaction would be greatly appreciated," Maijoor said in a letter to EU financial services commissioner Michel Barnier.

ESMA is proposing a breathing space of about 8 months so that derivatives entered into from March 18 until around November would not have to be cleared, even if ESMA decides by then that those types of contracts must be cleared in future.

The watchdog's first set of determinations on what should be cleared are likely around November or later.

The International Swaps and Derivatives Association (ISDA), a global industry body, said ESMA's approach should eliminate much of the uncertainty for derivatives end-users.

"ESMA's proposal looks to be a practical way of removing some of that uncertainty by clarifying that frontloading for eligible contracts will only apply once participants know which products will be subject to a clearing obligation, and when that mandate will begin," ISDA said in a statement. (Reporting by Huw Jones; editing by Mark Trevelyan)