On September 24, the UK Financial Services Authority (FSA) and the UK Treasury (collectively, the UK Authorities) released a response to the European Commission’s July 3 consultation on ways to reduce the risks of derivative markets (see the July 10 edition of Corporate and Financial Weekly Digest).

The UK Authorities welcomed the proposals by the Commission for enhancing the resilience of the over-the-counter (OTC) derivatives markets. They agreed with the Commission’s view that these markets have exhibited weaknesses, specifically in terms of counterparty risk management and market transparency, and that appropriate steps should be taken to strengthen these aspects in order to safeguard financial stability.

The UK Authorities outlined key steps which in their view will strengthen the OTC derivatives markets. They state that by ensuring that market participants have access to an appropriately robust, resilient and transparent market, authorities can help to improve confidence and financial stability both in the OTC derivative markets and the broader financial sector. The UK Authorities:

  1. support the Commission’s drive for further standardization of contract and economic terms. By using operational capital charges which are proportionate to the operational risks, the cost impact on non-standardized contracts will further encourage the use of standardized contracts.
  2. strongly support the greater use of central counterparty (CCP) clearing arrangements in OTC derivatives markets for products which are “clearing-eligible.” CCPs could offer a number of value-added services, such as the provision of additional market information which would encourage market participants to make greater use of CCP clearing.
  3. take the view that bilateral collateralization arrangements where market participants are unable to directly access CCP clearing, or are using non “clearing-eligible” contracts, remain important. These arrangements must be subject to robust risk management, which should include: regular (preferably daily) valuation and margin call processes; strong legal and operational frameworks; and appropriate capital requirements.
  4. share the Commission’s view that some market participants do not have adequate access to trade information. They support moves to address this, however they also noted that careful consideration will need to be given to how such a regime is implemented and how to ensure data accuracy.

The full response can be found here.