EU agrees new rules on 'shady' derivatives

Πηγή: EUobserver
BY NIKOLAJ NIELSEN

Feb 10 2012

BRUSSELS - The European Parliament, member states and the EU commission on Thursday (9 February) agreed the final text of new rules meant to bring transparecy to the over-the-counter (OTC) derivatives market.

EU regulations will screen derivative contracts (Photo: Images_of_Money)

"With this agreement, we are making a big step for financial stability. And we are substantially reducing the risk of a future financial crisis, with all its consequences on the real economy, growth, jobs and public budgets," EU internal markets commissioner Michel Barnier said after clinching the deal.

"The era of opacity and shady deals is over."

Before the banking crisis in 2008, around €2 trillion of derivatives were bought and sold every day in London alone. The September 2008 Lehman Brothers bankruptcy - widely seen as the start of the financial crisis - was largely due to the derivatives market guaranteeing bets on mortgages and loans that went bust when the US housing bubble burst.

The new regulations aim to increase transparency in OTC derivatives.

Around 95 percent of derivatives are not traded on a transparent exchange but are privately negotiated, with few reporting obligations.

"There are no public prices available, no public information as to who is entering deals with whom, over what period of time, relating to what underlying asset or for which amounts," the European commission has said.

Under the EU rules, supervisory authorities, including the European Securities and Markets Authority (ESMA) in Paris, will be able to scrutinise any European derivative transaction.

All such contracts will have to be reported to central data centres, also known as trade repositories. The repositories will publish and make public aggregate positions by class of derivatives in a bid to reduce the risk of default from anyone involved in the contracts. The ESMA will oversee the trade repositories and grant or withdraw their registration if need be.

Some members of parliament say the deal is not tough enough because it allows governments - at Britain's insistence - to impose a national veto over ESMA reactions.

"At the insistence of the UK, the ESMA would only be able to overrule the decision of a national regulator on the basis of unanimity. Unfortunately, member states were unwilling to ensure EU financial regulation agencies have sufficient and binding powers," said French Green MEP Pascal Canfin.

The European Parliament and member states still need to formally approve the bill before it comes into force.

The new rules will implement - in the EU only - a commitment made by G20 leaders in 2009 in Pittsburgh to reach a global deal before the end of 2012.

Derivatives: The $600 Trillion Time Bomb That's Set to Explode

Πηγή: Money Morning

BY KEITH FITZ-GERALD, Chief Investment Strategist, Money Morning
OCTOBER 12, 2011

Do you want to know the real reason banks aren't lending and the PIIGS have control of the barnyard in Europe?

It's because risk in the $600 trillion derivatives market isn't evening out. To the contrary, it's growing increasingly concentrated among a select few banks, especially here in the United States.

In 2009, five banks held 80% of derivatives in America. Now, just four banks hold a staggering 95.9% of U.S. derivatives, according to a recent report from the Office of the Currency Comptroller.

The four banks in question: JPMorgan Chase & Co. (NYSE: JPM), Citigroup Inc. (NYSE: C), Bank of America Corp. (NYSE: BAC) and Goldman Sachs Group Inc. (NYSE: GS).

Derivatives played a crucial role in bringing down the global economy, so you would think that the world's top policymakers would have reined these things in by now - but they haven't.

Instead of attacking the problem, regulators have let it spiral out of control, and the result is a $600 trillion time bomb called the derivatives market.

Think I'm exaggerating?

The notional value of the world's derivatives actually is estimated at more than $600 trillion. Notional value, of course, is the total value of a leveraged position's assets. This distinction is necessary because when you're talking about leveraged assets like options and derivatives, a little bit of money can control a disproportionately large position that may be as much as 5, 10, 30, or, in extreme cases, 100 times greater than investments that could be funded only in cash instruments.

The world's gross domestic product (GDP) is only about $65 trillion, or roughly 10.83% of the worldwide value of the global derivatives market, according to The Economist. So there is literally not enough money on the planet to backstop the banks trading these things if they run into trouble.

Compounding the problem is the fact that nobody even knows if the $600 trillion figure is accurate, because specialized derivatives vehicles like the credit default swaps that are now roiling Europe remain largely unregulated and unaccounted for.


Tick...Tick...Tick

To be fair, the Bank for International Settlements (BIS) estimated the net notional value of uncollateralized derivatives risks is between $2 trillion and $8 trillion, which is still a staggering amount of money and well beyond the billions being talked about in Europe.

Imagine the fallout from a $600 trillion explosion if several banks went down at once. It would eclipse the collapse of Lehman Brothers in no uncertain terms.

A governmental default would panic already anxious investors, causing a run on several major European banks in an effort to recover their deposits. That would, in turn, cause several banks to literally run out of money and declare bankruptcy.

Short-term borrowing costs would skyrocket and liquidity would evaporate. That would cause a ricochet across the Atlantic as the institutions themselves then panic and try to recover their own capital by withdrawing liquidity by any means possible.

And that's why banks are hoarding cash instead of lending it.

The major banks know there is no way they can collateralize the potential daisy chain failure that Greece represents. So they're doing everything they can to stockpile cash and keep their trading under wraps and away from public scrutiny.

What really scares me, though, is that the banks

think this is an acceptable risk because the odds of a default are allegedly smaller than one in 10,000.

But haven't we heard that before?

Although American banks have limited their exposure to Greece, they have loaned hundreds of billions of dollars to European banks and European governments that may not be capable of paying them back.

According to the Bank of International Settlements, U.S. banks have loaned only $60.5 billion to banks in Greece, Ireland, Portugal, Spain and Italy - the countries most at risk of default. But they've lent $275.8 billion to French and German banks.

And undoubtedly bet trillions on the same debt.

There are three key takeaways here:

• There is not enough capital on hand to cover the possible losses associated with the default of a single counterparty - JPMorgan Chase & Co. (NYSE: JPM), BNP Paribas SA (PINK: BNPQY) or the National Bank of Greece (NYSE ADR: NBG) for example - let alone multiple failures.
• That means banks with large derivatives exposure have to risk even more money to generate the incremental returns needed to cover the bets they've already made.
• And the fact that Wall Street believes it has the risks under control practically guarantees that it doesn't.Seems to me that the world's central bankers and politicians should be less concerned about stimulating "demand" and more concerned about fixing derivatives before this $600 trillion time bomb goes off.