UPDATE 1-Europe gives partial backing to U.S. derivatives plan

LONDON, May 14 - The European Union's executive stopped short of endorsing the United States' radical strategy for reforming the multi-trillion euro over-the-counter derivatives market, saying only that it backed Washington's broad aims.

Change is inevitable after the G20 group of industrialised and emerging market nations agreed in April that the credit default swaps part of the OTC market must be centrally cleared.

This dovetails with wider efforts to ensure that all parts of the financial market are regulated and help restore investor confidence by improving transparency and cutting risks.

"We seem to have similar objectives but we have not studied the details of the U.S. proposals," Commission spokesman Oliver Drewes said.

U.S. Treasury Secretary Timothy Geithner wants to go much further by also pushing all standardised OTC trades onto a regulated electronic platform such as an exchange.

He also wants other regions like the EU to follow suit to avoid them having an unfair advantage and lure away U.S. business.

"We will also need to work with authorities abroad ... so that achievement of our objectives is not undermined by the movement of derivatives activity to jurisdictions without adequate regulatory safeguards," Geithner said in a letter on Wednesday to Senate Majority Leader Harry Reid.

Bank of International Settlements figures showed that in April 2007, Britain accounted for 42.5 percent of daily OTC derivatives turnover, followed by the United States with 23.9 percent. France, Germany and Japan all had less than 10 percent. Global notional outstanding value was $684 trillion in June 2008.

Financial regulation is handled at bloc-wide rather than national level in the 27-nation EU.

Its plans for central clearing of CDS contracts in Europe from the end of July were progressing well and the Commission will publish its thoughts on the OTC market in June.

It is already consulting informally on whether other OTC products should be centrally cleared, such as commodity or equity derivatives but so far Brussels has stopped short of calling for a shift of trading onto exchanges.

REGULATORY DICTATION

The Commission declined to comment on this issue on Thursday and brokers hope Brussels will keep its nerve.

"There will be an awful lot of pressure on the European Commission to copy the American approach," said Anthony Belchambers, chief executive of the Futures and Options Association in London.

"My understanding is it's not part of the European Commission's brief to compel plain vanilla transactions onto an exchange. I would hope this would be left to market determination in Europe and not regulatory dictation," Belchambers added.

The United States going it alone would spark a flow of OTC business to Europe where it would be cleared, Belchambers said.

David Clark, chairman of the Wholesale Markets Brokers' Association, was disappointed policymakers "have still not grasped the essential notion that it's the clearing of OTC products that brings safety and not by forcing them onto an exchange."

"We are all aware Europe is looking very carefully at developments in the United States but it appears to have a firm grasp of the essential contribution that clearing of these products brings," Clark said.

Clark is a board member of British interdealer broker Tullett Prebon <TLPR.L>, a key player in the OTC market whose shares fell 8.6 percent on Thursday as investors responded to Geithner's policy statement. Analysts cited concerns over Tullett's lack of electronic broking or clearing capability. Exchanges like Deutsche Boerse <DB1Gn.DE> and NYSE Euronext <NYX.N> that own clearing operations are already savouring extra business from CDS clearing.

They would welcome regulators going a step further and pushing trades onto an exchange but have privately said that a thriving OTC sector helps broader financial market liquidity.

Industry officials said if the EU takes a similar line to the United States it could push some OTC business to non-EU Switzerland or even further afield to Singapore.