A derivatives deal, but the arguments continue

Finance ministers seek to regulate trading practice but UK concerned about losing business.

National finance ministers reached a deal last week (4 October) ending drawn-out negotiations aimed at regulating one of the financial sector’s more controversial practices, trading in derivatives. But even tougher battles could lie ahead.

Trading in derivatives – financial instruments whose value is derived from separate assets, such as commodities, interest rates and bonds – was blamed by some for exacerbating the financial crisis. EU policymakers have been keen to impose regulation for some time.

However, with about three-quarters of Europe’s off-exchange, or over-the-counter (OTC), trading taking place in London, attempts to enforce a new set of EU-wide rules put the UK at odds with all other member states.

The idea is to force OTC derivatives trading through central clearing-houses as a way of increasing transparency. The UK wanted the scope of the legislation extended to force all derivatives, including those traded on-exchange, through clearing-houses too.

London concerns

This is not just a matter of principle. The UK is concerned that if only OTC trades are regulated, London will lose trade to Germany’s Deutsche Börse. If a planned merger between Deutsche Börse and NYSE goes ahead, the new entity would have the lion’s share of exchange trades; if these remain unregulated, it will have a competitive advantage.

The UK’s stance is not about greater or lesser regulation, but about control. This was seen in another of its attempts to tweak the new legislation. The UK wanted a restriction in the power of the European Securities and Markets Authority (ESMA), a supervisory agency that started work at the beginning of this year. As part of the derivatives legislation, it would be able to block the authorisation of a clearing-house.

The UK won a concession. National regulators will be able to challenge any ESMA decision and demand that the authority’s college of supervisors hold a vote, with unanimous agreement needed from every member apart from the country concerned, before authorisation is halted. George Osborne, the UK’s finance minister, portrayed the original proposal as an effective “eurozone veto” against the City of London.

In the end, the UK dropped the demand for the scope to be widened to include exchange-traded derivatives. The European Commission will make a proposal to regulate these at a later date, probably in the Markets in Financial Instruments directive and regulation proposal, scheduled for publication next week (19 October).

However, the real tussle could be about to begin, as officials representing member states start to negotiate with the European Parliament, led by Werner Langen, a German centre-right MEP, who spoke out against any attempts to widen the scope to on-exchange trading. But further financial regulation is planned, notably a financial transaction tax, which is causing concern in the City of London: critics claim that it could see business shift to other parts of the world.

Future disputes might not be so much about preventing financial trading leaving London in favour of the eurozone, but rather about them leaving Europe altogether.