LONDON, Aug 29 (Reuters) - Companies that buy derivatives to guard against adverse price moves should use clearing houses rather than pay fees to banks to avoid unnecessary risks, the European Union’s risk watchdog said.
The European Systemic Risk Board (ESRB), based at the European Central Bank (ECB), said firms using banks to service their derivatives contracts may create extra risks because even for genuine hedging, the contracts are not risk-free.
Clearing houses, however, are backed by default funds in case one side of a deal goes bust.
The ESRB said bank fees drain companies of money and don’t guarantee that the risks being addressed have been covered adequately.
The ESRB plays no legislative role but its views carry clout. Its chair, Mario Draghi, is president of the ECB, which is expected to become the leading supervisor of euro zone banks, currently supervised by national regulators and the European Banking Authority.
World leaders have agreed that by the end of this year, huge swathes of the $648 trillion derivatives market should be traded on electronic platforms with the contracts centrally cleared where possible to increase transparency.
The bulk of the market is dominated by about 15 banks, which write bespoke contracts for firms for a fee.
But the opaqueness of the sector alarmed regulators when U.S. bank Lehman Brothers went bust in 2008, making it hard to see at a glance who was exposed to its derivatives holdings.
The EU’s European Securities and Markets Authority (ESMA) is finalising new derivatives rules for Europe and the ESRB signalled it wanted 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. (Reporting by Huw Jones; Editing by Helen Massy-Beresford)