The German MEP in charge of reporting on the European Commission’s plan to regulate derivatives markets has come out in favour of restricting or banning credit default swaps (CDSs). CDSs, where investors are paid if the underlying company or government defaults on its debts, make up around 10% of the private (over the counter) trade in derivatives. Traders in CDSs and other speculators have recently been blamed for inflating interest rates on Greek debt and destabilising the euro.

“CDS derivatives must be subject to independent central clearing; and, if necessary, where cumulative risks are involved, it must be possible to restrict them or, on a case-by-case basis, prohibit them,” Werner Langen (EPP) writes in his report, which was presented to MEPs in the Committee on Economic and Monetary Affairs (ECON), on 8 March. The EPP deputy told his colleagues during talks on the draft, “Those who have benefitted from the high opacity in this area are not going to welcome us with open arms”.

The move comes after the EU executive indicated it would look into tougher regulation on swaps of sovereign debt. The Commission is investigating a 2001 currency swap between the Greek government and investment bank Goldman Sachs to make sure it was in line with Eurostat’s accounting rules. Commission President José Manuel Barroso said in a statement, on 9 March, that he would consider banning “naked” CDS selling, where investors speculate without owning the underlying instruments.

INSURANCE CONTRACTS

Derivatives are highly complex products that are essentially insurance contracts between two parties. They are based on the value of an underlying asset – which could be a stock, bond, or commodity like oil - and money changes hands when a predefined event – such as an interest rate movement – occurs. Most are traded privately, rather than through exchanges, and are used to hedge positions or for speculation on future events. The Bank for International Settlements estimates that outstanding OTC contracts were worth around US$605 trillion last year, while exchange-traded products were worth around US$425 trillion, Langen says.

The Commission says that derivatives played a “central role” in the financial crisis, and that OTC traders significantly underestimated the risk of default. In two separate communications last year ⁽¹⁾, the EU executive came out in favour of forcing OTC products to trade on centralised exchanges and clearing houses.

Langen, the MEP in charge of scrutinising the communications, has said that CDSs should be more closely monitored than ordinary derivatives. He is also pushing for less stringent regulation for non-financial institutions and a greater role for the new European Securities and Markets Authority (part of the proposals on supervision) in regulating exchanges.

MEPs will have until 24 March to present their amendments and ECON will hold a committee vote, on 4 May.

⁽¹⁾ COM(2009)0563 and COM(2009)0332