EU-US move closer to deal on derivatives regulation

US treasury secretary calls for EU-US co-operation while Michel Barnier welcomes US’ ‘level of ambition’.

The European Commission has reached agreement in principle with the United States on regulation of the derivatives market. 

Timothy Geithner, the US treasury secretary, has written to Michel Barnier, the European commissioner for the internal market, setting out a reform plan and calling for EU-US co-operation, which he said was essential to address systemic risks posed by derivatives that are traded between counterparties off exchanges, known as over-the-counter (OTC) derivatives.

A spokeswoman for Barnier said that the commissioner “very much welcomed the level of ambition” in Geithner’s letter. She said Geithner’s proposals were “completely in line” with a draft law that Barnier will present in June. Barnier’s proposal would then have to be agreed by the EU’s member states and the European Parliament.

US priorities

Geithner’s letter sets out four priorities for reform, namely: subjecting the market to substantial supervision and regulation (including conservative capital requirements); pushing all trading of standard (ie, commonly traded forms of) derivative contracts onto exchanges or other regulated trading platforms; obliging all traders of standard derivative contracts to use central counterparty clearing; and giving regulators full authority to monitor transactions (including setting position limits).

Barack Obama, the US president, is currently pushing Congress to include regulation of derivatives trading in a financial reform bill that he wants adopted by the end of May. He said last week that he would veto any version of the bill that did not cover derivatives. Obama said that the US “can’t afford another AIG” – a reference to the insurance company American International Group, which had to be bailed out by the US government at the height of the financial crisis because of overexposure to the derivatives market.

The tougher approach to derivatives has been incorporated into draft versions of a communiqué that G20 finance ministers are to adopt at a meeting in Washington, DC, tomorrow (23 April). The Geithner letter goes further than reforms agreed at the last G20 summit, held in September in Pittsburgh, which agreed that standardised contracts should be cleared on exchanges “where appropriate”. It also goes farther than the European Commission’s most recent policy paper on derivatives reform, from October 2009, which stopped short of proposing that all derivatives trading should be carried out on exchanges.

Co-ordinated regulation

The Geithner letter says that the EU and US should co-ordinate how they regulate non-financial firms that use the derivatives markets to hedge risk. Both the Commission and the US administration support a lighter regulatory regime for these companies, which only account for a small part of the over-the-counter market. Geithner has sent a similar letter to Jean-Claude Trichet, the president of the European Central Bank.

The G20 meeting is also expected to discuss international co-operation to wind up failing banks, and to address macroeconomic imbalances. The meeting will prepare the next summit of G20 leaders, which will take place in Toronto on 26-27 June.

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