The European System Risk Board (ESRB) is urging companies that buy derivatives to guard against adverse price moves to use clearing houses, rather than pay fees to banks, to avoid unnecessary risks.
The ESRB, which is based at the European Central Bank (ECB) and acts as the EU’s risk watchdog, said that firms using banks to service their derivatives contracts may create extra risks because even for genuine hedging, the contracts are not risk-free. However, clearing houses are backed by default funds in case one side of a deal goes bust. It added that bank fees drain companies of money without providing any guarantee that the risks being addressed have been covered adequately.
Despite playing no legislative role, the ESRB’s views are influential. Its chairman, Mario Draghi, is also president of the ECB, which is expected to become the leading supervisor of eurozone banks currently supervised by national regulators and the European Banking Authority (EBA).
World leaders have agreed that by the end of this year, huge swathes of the US$648 trillion derivatives market should be traded on electronic platforms with contracts centrally cleared where possible to provide greater transparency. The market is largely dominated by a group of about 15 banks, which write bespoke contracts for firms for a fee.
The EU’s European Securities and Markets Authority (ESMA) is finalising new derivatives rules for Europe and the ESRB indicated that it favours a tough approach on commercial users even though they are seen as valid users of the instruments.
Airlines, for example, use derivatives to hedge against price spikes in jet fuel or to insure against adverse currency or interest rate moves hitting other production costs. Such users will be exempt from having to clear contracts up to a certain threshold, while other types of users must clear any contract if there is a clearing house available. Companies have warned they may avoid hedging if they are forced to clear many contracts, putting a burden on cash flows.
The ESRB said that some parts of the market, such as commodities, were mainly used by companies for hedging, but the use of derivatives in these areas for speculative, investment and trading purposes has become predominant.
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