EU tells derivatives market to clean up

BRUSSELS, Oct 22 - Europe's financial sector was told on Wednesday it has only weeks to "clean up" trading of the near $60 trillion credit derivatives market, blamed by some policymakers for helping to create the worst market turmoil in 80 years, two industry sources said.

European Union Internal Market Commissioner Charlie McCreevy summoned a broad range of trading associations, regulators and central bankers to a meeting in Brussels to discuss how the vast over-the-counter sector can be made safer and more transparent.

"He wanted concrete proposals next month on how the market can be cleaned up," one source who attended the meeting said.

McCreevy has powers to propose mandatory regulation of financial services across the 27-nation EU.

"There was a consensus that centralised clearing is a prerequisite," a second source who attended the meeting said.

Exchanges and clearing houses, often with shared ownership, already sense lucrative opportunities as they face squeezed margins elsewhere such as from greater competition in trading shares.

The U.S. Federal Reserve is already pushing the financial industry to clear over-the-counter contracts, a step that ensures risks are mitigated and two rival offerings are already underway, one involving derivatives giant CME.

Eurex, the derivatives arm of Deutsche Boerse that also includes a clearing platform, said centralised clearing would strengthen the integrity and stability of the credit derivatives market.

"We are open to creating a consortium with credit default swaps users," Eurex CEO Andreas Preuss said in a statement.

Industry associations such as the International Swaps and Derivatives Association told McCreevy that the sector has already solved many of the problems he has raised and that the sector was "robust and resilient" as shown by the recent auction of Lehman derivatives, the sources said.

But regulators at the meeting said there should be the same level of transparency as in the stock market which mostly trades on exchanges.

The regulators want mandatory clearing of off-exchange traded derivatives, with links between the clearing houses, intra-day netting and possibly links with the European Central Bank according to the sources.

The OTC sector trades bespoke derivative contracts such as credit default swaps, which are a type of insurance against a company's debt defaulting but the watchdogs want far more standardisation of contracts, the sources added.

"The real worry of the regulators is that they don't know what derivatives are out there and this level of risk gives rise to market manipulations," one source said.

An industry and regulatory group will be set up to look at short and medium term options and put forward solutions from early next month.

Tougher action cannot be ruled out as Brussels is under heavy political pressure.

"We will look at regulating derivatives," European Commission President Jose Manuel Barroso told the European Parliament on Tuesday.

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