LONDON The European Union's securities watchdog published draft rules on Monday to meet a December global deadline for making the derivatives market safer and more transparent.
The draft rules, open to public consultation ahead of finalization in September, will help determine the future economics and shape of a sector which was opaque with contracts mainly traded among banks.
The $640 trillion over-the-counter (OTC), or off-exchange, derivatives market lay at the heart of the 2007-09 financial crisis, contributing to the collapse of U.S. bank Lehman Brothers and a taxpayer bailout of U.S. insurer AIG (AIG.N).
"OTC derivatives impact both financial markets and the real economy but have not been subject to regulatory requirements," said Steven Maijoor, chairman of the European Securities and Markets Authority (ESMA).
ESMA's draft technical standards provide banks in the 27-country EU with the long-awaited detail of how to implement a framework law the bloc has already passed.
The rules define which contracts must be cleared, a procedure backed by a default fund so a transaction is completed even if one side of the deal goes bust, and how clearing houses must be operated so that increased risk from handling greater volumes in future will be contained.
ESMA said in its draft rules that no clearing house will be forced to clear contracts it is not able to manage.
Companies which use derivatives to "hedge" or insure against adverse moves in interest rates or raw material prices have worried this could be costlier in future.
ESMA said it has widened the type of contracts that can be included under commercial hedging and thus be exempt from clearing. It will include proxy hedging whereby the contract is linked to an asset that is closely correlated to the risk being insured. It rejected the inclusion of stock option plans.
The watchdog will introduce "thresholds" for five derivatives classes, below which clearing won't apply.
The threshold for credit and equity derivatives will be 1 billion euros in notional value, and 3 billion euros for derivatives linked to interest rates, foreign exchange and commodities.
Leaders of the world's top 20 economies (G20) have agreed derivatives reforms must be in place by December.
The derivatives industry, which gathers in London this week, is also waiting for global regulators to come up with the final missing pieces that will reshape the sector: a global minimum margin for uncleared trades and capital charge on all cleared trades.
The global Basel Committee on Banking Supervision is expected to come forward with draft proposals soon.
Although the G20 has agreement on the broad thrust of derivatives reforms, regulators on both sides of the Atlantic are eyeing one another for attempts to reach into each other's jurisdictions.
Markets in Asia are in turn looking at how the United States and EU are implementing the G20 derivatives reforms before complying themselves.
(Editing by Mark Potter)