A sweeping reform of Europe's derivatives market will be rolled out over several months and not with a "big bang" in January to allow banks time to bed down the system before they risk enforcement action, regulators said on Tuesday.
World leaders agreed in 2009 during the financial crisis to crack down on trading in the opaque $648 trillion derivatives market that is conducted mainly between 15 of the world's biggest banks.
The new regulations requiring electronic trading, clearing and reporting of derivatives trades were prompted by the collapse of U.S. bank Lehman Brothers in Sept. 2008 and the time it took regulators to identify its counterparties.
Regulations will cover derivatives that have traditionally been traded off an exchange such as credit default swaps, interest rate swaps and commodity derivatives. Futures traded on exchanges are already cleared.
The new rules are part of a slew of tighter regulation faced by banks – such as tougher capital and liquidity requirements – aimed at curbing aggressive risk-taking and protecting taxpayers from having to bail out financial institutions again.
The European Securities and Markets Authority (ESMA) will later this month publish rules for implementing the derivatives shake-up in the 27-member European Union and set a new timetable.
The January start agreed by world leaders cannot be met because regulators say neither the new rules nor the banks will be ready in time.
Edouard Vieillefond, head of regulation policy at the AMF, the French markets watchdog and member of ESMA, said it will take until June to authorise clearing houses. This would be followed by approval of which contracts can be cleared.
"It means that the rules will be ready from a legal and regulatory point of view from the beginning of the year but for the practical obligations, we are talking about summer of 2013 or the beginning of September," Vieillefond told Reuters on the sidelines of a Trade Tech conference.
Banks have already begun clearing some of their derivatives such as credit default swaps and interest rate swaps.
Another EU regulatory source said new trades will have to be reported from June 2013, with trades up to that date reported by the end of 2013. Voluntary reporting of some trades has begun.
Two major components of the new rules have yet to be completed.
It is not clear how big should capital charges – cash put to one side to cover the risk of default – should be on cleared and uncleared trades.
There is also no regulatory consensus on whether uncleared trades should have an initial and a so-called variation or day-to-day margin which helps to cover potential losses on a contract.
"Our position is there should be an initial margin for everyone," Vieillefond said.
INTERPRETATION
Banks want as much detail about the new rules now so they can start investing millions of euros to adapt their systems. The new capital charges and margin requirements will also make trading derivatives more expensive.
The aim is that it will be cheaper to clear trades rather than leave them uncleared. Clearing is seen as safer as it is backed by a default fund if one side of the transaction goes bust.
"The first assessments that have been made are quite reassuring in that the CVA capital charge is so demanding on a bilateral basis that normally the incentive to clear is in the right direction," Vieillefond said.
"If in certain cases we feel that the incentives are the other way round then we will need to correct on one or two parameters."
Regulators acknowledge they may not get the rules right from day one and that tweaks may be needed later, adding to uncertainty.
Tom Springbett, manager of OTC derivatives and post trade policy at Britain's Financial Services Authority said there is flexibility to give banks time to interpret the new rules. The bulk of derivatives are traded in London and New York.
"Where there are opportunities to allow more time, we at the FSA intend to support the taking of those opportunities," Springbett told the Trade Tech event.
He said regulators will not be heavy handed and jump in immediately with enforcement actions if banks have "legitimate differences in interpretation" of the rules.
Industry should accept some uncertainties so that regulators can see if the rules have the right impact or need changing.
"If we can accept those downsides for the early months and perhaps years of these regulations then we get better outcomes than if we try to codify everything to the nth degree now, when we don't really have a full picture of how we want things to work in practice," Springbett said.
