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EU executive to crack down on derivatives risk

The European Commission said it intends to make proposals to control risks in the $60 trillion credit derivatives market, seen as one of the causes of the worst financial crisis in 80 years.

“Regulators need to have a much better view of where the real risks in these instruments lie,” EU Internal Market Commissioner Charlie McCreevy said in a statement.

“I would like to have by the end of this year concrete proposals as to how the risks from credit derivatives can be mitigated,” McCreevy said.

The contracts are traded over-the-counter or off an exchange, and are therefore more lightly regulated with risks less controlled.

Contracts could be standardized more, McCreevy said.

“But there is a far more pressing need and that is to have a central clearing counterparty for these derivatives,” he said.

Standardized derivatives are already traded and cleared on exchanges such as Eurex, Liffe and the CME. But the off-exchange market, with its bespoke contracts, is far bigger.

One sector, credit default swaps (CDS) are “insurance” against a company defaulting and have been widely traded, with poor records of where these contracts have ended up or whether the owners have the capital to honor them if needed.

Central clearing for credit derivatives such as CDS contracts was particularly urgent, McCreevy said.

“No one is able to say how these swaps will unwind. Regulators have little sight of potential liabilities that could be building up for individual participants,” he added.

McCreevy's moves mirror those in the United States where the Securities and Exchange Commission and Federal Reserve Chairman Ben Bernanke have said there should be more oversight of credit derivatives.

The Commodity and Futures Trading Commission, which oversees derivatives in the United States, has said centralized clearing of contracts is an “immediate” step that could be taken to cut risk.

Liffe said on Thursday it has struck a deal with Markit Group, a financial information provider, to launch exchange-traded credit default swaps that are cleared centrally. (Reuters)