* New rules set to regulate roughly $700 trillion market
* EU's Barnier: era of shady deals is over
* Law will ensure trades recorded under eye of regulators
By John O'Donnell
BRUSSELS, Feb 9 European Union diplomats
and the European Parliament agreed on Thursday to overhaul
regulation of the roughly $700 trillion derivatives market, a
move that will make it easier to control one of the most opaque
areas of finance.
The new regime, which could be largely in place by the end
of 2012, will overhaul a market that boomed in the decade before
the economic crash and was blamed for amplifying the crisis by
hiding risks from regulators.
Under new EU laws, banks, hedge funds and other buyers and
sellers of derivatives will be encouraged to move away from the
unregulated 'over-the-counter' market, which accounts for almost
95 percent of all trades.
"The era of opacity and shady deals is over," said Michel
Barnier, the European commissioner in charge of writing these
and other new rules to reform finance.
"It is a key step in our effort to establish a safer and
sounder regulatory framework for European financial markets."
In the past, it has been common for multi-million-euro
contracts to be recorded by no more than a fax, with only the
parties involved aware of the details.
This will change under the new law, which would standardise
most trading so it happens on open exchanges. Settlement of such
deals will be cleared centrally, making them easier to monitor.
Those that do not shift to exchanges or a central
counterparty such as LCH Clearnet in London, which acts as an
intermediary between buyer and seller, will face higher capital
charges to reflect the extra risk.
Crucially, the new rules mean that all deals must be
recorded, whether conducted on or off an exchange.
Supervisors hope that will make it easier to monitor the
market and intervene, if necessary, to avoid a repeat of the
chaos surrounding the 2008 collapse of Lehman Brothers, where it
proved difficult to assess exposure to derivatives.
By forcing increased transparency, the rules are likely to
challenge the half a dozen or so large banks that dominate the
These banks, including Deutsche Bank, Barclays
, Goldman Sachs, JP Morgan, Bank of
America and Citigroup, design such products for
customers and trade them among themselves.
The United States has been quicker to implement controls,
establishing a regulatory framework in 2010 for derivatives,
such as those that hedge the risk from price moves on oil, gas
or other commodity markets.
Derivatives, such as options, futures, swaps or forwards,
derive their price from the underlying asset; such contracts can
be drawn up between parties setting out conditions under which
the contract may or may not pay out.
The market for the instruments once described by billionaire
investor Warren Buffett as weapons of financial mass
destruction, is largely unchartered.
The opaque nature of the market for credit default swaps
(CDS), for example, made it difficult to predict the fallout of
a Greek debt default or similar dramatic event.
Under the new European rules, which were discussed with
industry before negotiations moved to the European Parliament
and EU member states, all CDS trades would be recorded, making
such predictions easier.
Writing laws to regulate derivatives in Europe has divided
the region's top powers - Germany, France and Britain - with
Britain keen to protect the City of London, which accounts for 9
percent of Britain's economy and dominates the derivatives
market, alongside New York.
Some analysts see risks in the new regime and think
regulators will be overwhelmed by trying to follow such a huge
"By centrally clearing trades, you concentrate risk
dramatically into one body, such as a central counterparty,"
said Graham Bishop, who advises banks on European financial
"We have to be careful these bodies don't become a financial