20 Mar 2010

Coordinated EU and US action on derivatives markets

After the US Treasury Secretary, Timothy Geithner, had warned Brussels that its plans to regulate hedge funds and private equity groups may spark a transatlantic row, the EU and US officials have agreed on Monday to cooperate towards making the speculators' favourite playground, the derivatives market, more transparent.

The Financial Times had earlier reported on a draft EU directive imposing tighter restrictions on US investment funds. The proposed new rules aim to regulate US hedge funds, private equity groups and banking activities with and within Europe.

They restrict the access of EU investors to funds based outside the 27-nation bloc, while non-EU funds would also be forced to comply with the new regulations in order to be able to engage in EU trading.

Last October, the European Commission announced plans to introduce, by the end of 2010, a central clearing agency to regulate the over-the-counter derivatives'. Much of this trading is done privately, outside the trading floor. The collapse of the US investment bank Lehman Brothers, in 2008, has already highlighted the risks involved in such shoddy practices.

The European Commission's chief, Jose Manuel Barroso, told the EU parliament in Strasbourg, last week, that the commission regulators "will examine closely the relevance of banning purely speculative naked sales on Credit Default Swaps (CDS) of sovereign debt."

Much like with the "naked Emperor", such "naked selling" practices mean taking out insurance on bonds or other types of debt without actually owning them, which is nothing but a purely speculative gamble accounting for the majority of CDS trading.

"Credit default swaps is one (area) where we're exploring together how to best protect the public and the markets," said Gary Gensler, chairman of the US Commodity Futures Trading Commission (CFTC).

Credit default swaps are derivative products, aimed at covering the risk of a debtor defaulting. This derivatives' gambling market has recently been thrown into the spotlight by reports of coordinated market action by multi-billion-dollar hedge funds to bring down the value of the euro in the wake of the Greek crisis.

"We are talking about standardisation and registration for considerable sums, 600 trillion dollars in derivatives products, 80 percent of which escape any transparency," said EU Financial Services Commissioner, Michel Barnier.

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