UPDATE 1-EU proposes rules to stop 'too big to fail' clearing houses

(Adds more detail, industry reaction)

LONDON, Nov 28 (Reuters) - The European Union has proposed rules for dealing with failing clearing houses to try to stop the rapidly growing sector from becoming “too big to fail” and holding taxpayers to ransom in a crisis.

Clearing houses stand between two sides of a stock, bond or derivatives transaction, ensuring its completion even if one side goes bust.

Far more derivatives will have to be cleared in future to improve transparency and safety in the sector, meaning that clearing volumes will swell.

“This proposal will strengthen Europe’s financial system further and aims at protecting taxpayers by ensuring we can deal with a central counterparty if it falls into difficulty,” European Commission Vice-President Valdis Dombrovskis said in a statement.

The rules, first reported by Reuters last month, will need approval from EU states and the European Parliament to become law, with some changes likely.

The draft law is in line with principles agreed at a global level in the aftermath of the 2007-09 financial crisis and already implemented in many cases.

EU rules will ensure consistency across the 28-country bloc and ensure all regulators have a “resolution authority” with a suite of powers to intervene early enough to avoid a failing clearing house sparking mayhem in markets.

The powers include an ability to write down bonds and mandate cash calls to bolster a clearing house’s defences.

Asset managers have lobbied to avoid having their assets in a failed clearing house being eaten up in a rescue, saying these assets belong to investors.

The EU draft law skirts the issue by not mandating which powers must be used and in what circumstances, leaving the choice to the regulators.

Rafael Plata, secretary general of the European Association of Clearing Houses, an industry body, welcomed the consideration of many tools for dealing with a failed clearer, but without prescribing when or for which cases they should be used.

“This would allow central counterparties and resolution authorities to solve this extreme event rapidly,” Plata said.

Clearing houses such as Eurex Clearing and LCH in Europe should have “recovery plans”, spelling out measures they would take to deal with any financial distress.

Regulators must draw up “resolution plans” spelling out how a failed clearing house would be restructured and their basic operation maintained.

Clearing has become caught in the crosshairs of Britain’s vote in June to leave the European Union.

French President Francois Hollande has said clearing in euro-denominated contracts, which LCH in London dominates, should be shifted to the euro zone after Britain’s vote to leave the EU.

There are 17 authorised clearing houses in the EU which clear a significant proportion of the global $493 trillion market.

Reporting by Huw Jones; Editing by Mark Potter and Louise Heavens