Derivatives Traders May Face Position Limits Under EU Proposal

Oct. 20 (Bloomberg) -- Traders may face limits on positions they can take in the over-the-counter derivatives market, valued at $592 trillion, under a draft European Union proposal.

The European Commission will propose rules giving regulators the authority to set limits “to counter excessive price movements or excessive concentration of speculative positions,” according to a draft proposal obtained by Bloomberg News. The proposal could be released as soon as today.

The Commodity Futures Trading Commission, which oversees U.S. derivatives, has pushed for position limits under proposals for regulatory change. European and U.S. regulators are concerned that derivatives could create systemic failure in the financial system, akin to that experienced after the collapse of Lehman Brothers Holdings Inc. last year.

“This will create waves,” said the Federation of European Securities Exchanges in an e-mail. “The background to this is that there were discussions on position limits that the CFTC wanted. The Commission wants a level playing field between the U.S. and Europe.”

Oliver Drewes, spokesman for the commission in Brussels, declined to comment. The EU in July called for the use of clearinghouses for some over-the-counter derivative trades to ensure financial stability.

Rules for central counterparties, which are regulated at a national level, should be harmonized across the 27 EU-member states, the draft says. Regulators may draft ruled to “ensure that CCP participants will benefit from the lowest possible regulatory capital charge” for contracts cleared centrally.

Ambitious Targets

Derivatives are used to hedge risks or for speculation. They’re derived from stocks, bonds, loans and commodities, or linked to specific events like changes in interest rates.

The commission said in the draft document that it would set ambitious European targets and strict deadlines “for legal and process standardization.”

“That, on balance, will be positive,” Richard Portes, founder of the Centre for Economic Policy Research, said in a telephone interview. “It is the excessive complexity that has got us into this mess in the first place”.

Companies are concerned that so-called “one-size-fits- all” regulation would raise their costs of hedging risk and deny them access to customized derivative contracts. Companies use OTC derivatives to reduce the impact of commodity price volatility, such as oil, on their earnings.

The commission has started to write the derivative legislation and expects to release it by mid-2010, according to the draft.