Echoes Across the Pond: The European Commission’s Path to OTC Reform and Global Harmonization

Last week, the U.S. House of Representatives passed historic financial regulatory reform legislation, which included an overhaul of the OTC derivatives market that is sure to have a ripple effect through the Senate and, if global harmonization is to occur, across the pond in Europe.

Globally, all eyes are on how end-users will ultimately fare under U.S. reform as it is this group of users that will impact the direction of the European Commission (EC) if global harmonization is the goal.  But if we look back on the spring of 2009, we can see that the U.S. Administration’s approach to reform, with respect to end-users of OTC derivatives, was originally more stringent than the thinking coming out of the EC.  So far, U.S. lawmakers have listened to the concerns of non-financial corporations that use OTC derivatives to hedge business risks, and, with the exemption from clearing for FX swaps and FX forwards, it appears that end-users will not be as impacted as originally feared.

The EC, in the meantime, has issued directives that avoid creating broad loopholes for end-users and favor posting of collateral by all participants in the OTC derivatives market, ideally through margin requirements for exchange traded instruments and transactions cleared with a central counterparty (CCP) or through postings of cash or other securities for transactions not cleared.

In addition to any potential differences in treatment of end-users, the U.S. and the E.U. may differ in timetables.  I would be surprised if U.S. legislation isn’t passed by the end of Q1 2010. Unlike the healthcare debate, there isn’t going to be much resistance to passing the reform, especially now that the end-user debate is subsiding.  However, the timetable for the E.U. could be anywhere from one to three years behind the U.S. as the 2010 timetable for the EC does not include passing of legislation (see EC Directive).