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Mr. Charlie McCreevy
European Commissioner for Internal Market and Services
Derivatives and Risk Allocation
Derivatives Conference Speakers' Dinner
Brussels, 24 September
Ladies and Gentlemen,
I'm very pleased to welcome you here today, one year and 9 days after the collapse of Lehman sent its shockwaves through the economy. Even though AIG was bailed out the day after, it could not prevent the collapse of the interbank market. More bad news followed by the day. Our economies went deep into recession. Government interventions followed building up enormous liabilities for taxpayers.
Now, thanks to these interventions, the economic forecasts show that there's some light on the horizon. So we have not come here for our last meal. This is not going to be a light meal either, because we're here to talk about "weapons of mass destruction", as derivatives have come to be known.
The idea of a derivative – writing a contract for a simple transfer of risk – is centuries old. But since the last (and much smaller) financial crisis, the burst of the IT-dotcom bubble almost 10 years ago, their use has exploded – ironically because information technology has allowed for ever-more complex risk modelling. So in a way derivatives are the ultimate financial innovation. Designing proper regulation is far more intricate than one would expect for a centuries-old idea.
Some like it simple though: Just "freeze the OTC derivatives market" (I'm quoting George Soros here). Behind this is perhaps the conjecture that, instead of transferring risk, OTC derivatives have become the tool for the financial world to just conceal risks. But on the other hand, many companies have come to love and need derivatives. And they are expressing their worries that a rigorous approach would make their hedging more expensive and thus expose them to more risk.
When the crisis started, neither the market nor supervisors knew who was bearing what risk in the economy. But now, it has become obvious: It's the taxpayer.
And that is certainly not right. So we are here today to find ways to ensure that derivatives can allocate the risks in the economy better. In July, we presented preliminary views on this.
Based on our current thinking and the US proposals of August, I'll try to sketch what seems to have broadly emerged as the "transatlantic consensus" on this:
The route to get there has still to be worked out. You have seen our consultation paper. We have received a hundred or so responses which we have analysed. But before we draw any operational conclusions, I would like to use tonight's discussion and tomorrow's conference to get the views of regulators, academics and industry on a number of issues.
The first issue is central clearing: At the end of July, two European central clearing counterparties (CCPs) (ICE Europe and Eurex) began clearing credit default swaps (CDSs) in the EU. This is the outcome of a significant industry effort – admittedly with a good push from us and other regulators. There is a consensus that we should expand the use of CCPs beyond this.
The question is how to do this: Should we provide incentives, for example through regulatory capital, or should we mandate the use of CCPs? How can we ensure smaller banks and companies use CCPs broadly? How should CCPs be regulated and supervised in the single market bearing in mind their systemic relevance? I am concerned that the process of authorising the two CCPs which clear CDSs in Europe has not been entirely frictionless.
The second issue we want to discuss are central data repositories: The market is in the process of setting up such repositories. Although no fiscal responsibility is involved, some issues here are similar to the ones related to CCPs: Should the use of repositories be incentivised or mandated by law? How do we ensure data quality? Who supervises these repositories? How do we ensure equal access of supervisors to the data stored in those repositories?
A third area we need to examine is what to do about bilateral clearing: CCP-clearing can only cover a subset of the market. Some derivatives are too bespoke to be centrally cleared. If we incentivise the use of CCPs that implies in turn that we will make bilateral clearing more costly. Or more bluntly: Bilateral clearing will reflect better the social cost of counterparty risk, which is now partly borne by the taxpayer. One approach might be stricter collateral requirements. We could also think about raising the regulatory capital cost for bilaterally-cleared products.
A fourth concern I have is how to incentivise standardisation without stifling innovation: Let me be clear. I think the level of standardisation, particularly when it comes to some procedural aspects, is unacceptable. The level of electronic confirmation of trades is "so last century". More 1920s that 1990s… So how do we bring this industry into the 21st century? I could think of setting clear targets with precise deadlines and working with industry on how to implement those targets. But maybe others have other suggestions.
A fifth issue for discussion: Do we need to impose certain requirements for the trading of derivatives? The US seems to be going that route. We shall follow their discussions very closely. What seems certain is that there will have to be much more transparency in the reporting of trades.
Finally another topic on which I would welcome views: Are there any products which are so toxic that they should be banned? Some seem to advocate that. While I certainly think there have been excesses, I am not sure whether banning products is the answer. But I am convinced this is a discussion which needs to take place.
Tonight we have academics, representatives from the industry, some of which have been in the derivatives business from the beginning (though not for centuries!) and key regulators. Gertrude Tumpel-Gugerell and Jochen Sanio will share their views with us later.
Although there are representatives from the press this will be a discussion under Chatham House rules. So I invite you all to be open and frank.
I'm particularly happy that my colleagues from the US were able to make the long journey. If there is one issue in financial services where we need convergent solutions this is it. And in the coming months I expect us to talk to each other and agree on such solutions. So let me welcome and give the floor to Gary Gensler, who I am sure will help broaden the "transatlantic consensus".