The European Commission has proposed draft rules on financial trading with Single Market Commissioner Michel Barnier comparing the derivatives market to “a Wild West territory”.
Mr Barnier said: “Over the counter derivatives have a big impact on the real economy. The absence of any regulatory framework for OTC derivatives contributed to the financial crisis and the tremendous consequences we are all suffering from.”
The derivatives market is made up of financial instruments which derive their value from an underlying asset or credit, and has boomed in recent years. In December 2009, the notional value of OTC derivatives was $615 trillion – almost ten times larger than the entire global economy.
Since they are traded over the counter or off exchange, these deals escape the watch of regulators. However, it is hoped the new European Union legislation will establish EU-wide rules to increase transparency and clamp down on speculation.
The Commission wants to create a watchdog to monitor the derivatives markets, while Commissioner Barnier also stated his desire to establish EU-wide regulations that would make investors disclose details of their short positions in shares to a central database.
Draft regulations include a clampdown on naked short selling, when a trader or institution sells a financial product which they have not yet borrowed. However, it is likely that the Socialist and Democrat group and other political groups will seek to ban such forms of short selling.
The proposals, which will now be discussed and amended by national governments and MEPs in the European Parliament’s economic committee, also focuses on the extent of short selling – when traders bet on asset prices falling. It includes a requirement that derivatives trades go through a central clearing house to ensure that investors have enough money to pay up if they lose what is, in effect, a bet.
In May, Germany temporarily banned some forms of short-selling of financial products in response to economic instability caused by speculation on sovereign debt. It is widely understood that manipulation of the derivatives market in this way was the underlying cause of much of the economic instability during the recent international financial crisis.
