Global regulators' failure to align efforts to reform the $693trillion derivatives market threatens to undermine economic growth,according to the International Swaps & DerivativesAssociation.

Investors are struggling to adapt to regional differences tochanges agreed by the Group of 20 nations as the industry meets forits annual conference in Munich today. In the U.S. traders havebeen reporting derivatives transactions to data repositories andhave been required to have central clearinghouses back theircontracts since last year, while European regulators are stilldefining the requirements.

Rules introduced after the collapse of Lehman Brothers HoldingsInc. to reduce systemic risk have increased transparency, thoughthey've also made hedging more expensive, according to an ISDAsurvey published yesterday. Legislators say the changes willenhance their ability to monitor risk taking, curb market abuse andmake it easier to identify holdings when a financial institutionfails.

“People who need to conform to the rules are without a doubtincurring increasing costs and complexity,” Alan Haywood, presidentof downstream gas at BP Plc and an ISDA board member, said in antelephone interview before the conference. “As an internationalcompany working with international counterparties, we wantregulation to be pretty consistent worldwide.”

In the wake of the financial crisis, G-20 leaders agreed to seekto push trading as much as possible through central clearinghousesand onto regulated platforms.

The U.S. Dodd-Frank Act mandated that most swaps be backed witha clearinghouse and traded on swap execution facilities, or SEFs,and that all trades be reported to central repositories. Theclearing and reporting mandates went into effect last year.Measures are already in place in several other nations includingBrazil and Japan.

Though firms in Europe have begun systemic reporting and willstart trading contracts through central counterparties by the endof the year the European Securities and Markets Authority, theregion's main regulator, is still struggling to define a derivativeand harmonize rules across the 28-nation bloc.

“It's a real challenge to implement regulation consistently onan international basis,” Elke Koenig, president of German financialregulator BaFin, said at the ISDA conference today. “Fragmentationleads to misallocation and possibly market distortions andinefficiencies.”

Clearinghouses

Clearinghouses rely on bank members to provide billions ofdollars' in cash and assets to hold on reserve in case of adefault. They're meant to lessen systemic risk by requiringup-front margins to back every trade and monitor prices throughoutthe day. When losing positions arise, they demand cash so that riskdoesn't build.

The U.S. rules effectively place the responsibility on banks forreporting trades, while the EU's approach requires both buyers andsellers to post positions, bringing more non- financial companieswithin the scope of the measure.

“Differences between jurisdictions are very harmful and the moredialogue and more concerted efforts towards global harmonization ofrules the better,” Stephen O'Connor, ISDA's chairman, said in aninterview before today's meeting. “We'd encourage a great deal moreinternational cooperation.”

Attempts by U.S. regulators to extend their oversight have alsocaused market fractures, he said. ISDA said in December and Januarythat foreign investors have avoided trading with U.S. firms sincean Oct. 2 deadline for platforms to register with the CommodityFutures Trading Commission.

The derivatives industry is also facing pressure from theFinancial Stability Board, a global grouping of central bankers andregulators, to come up with proposals to write temporary pausesinto derivatives contracts struck with banks that hit financialtrouble.

Mark Carney, chairman of the FSB and governor of the Bank ofEngland, told journalists last week there was “no lessening” on thefocus on so-called contractual stays in derivatives. The measurescould prevent the type of turmoil in markets seen with the collapseof Lehman Brothers in the event of another investment bankingfailure, regulators have said.

Regulators must update G-20 finance ministers on their progressin September.

“Financial markets are global and our preferred outcome would befor all regulators across the world to move at the same time to thesame set of rules,” O'Connor said. “The problem is that justdoesn't happen in the real world.”

Bloomberg News

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