Medway Liberal Democrats

Speech to the ISDA Conference in London

In July I became the new Chair of the Economic and Monetary Affairs Committee in the European Parliament.

That committee is colloquially known as ECON - so if I slip to calling it that you will know what I mean.

The committee has among its responsibilities all financial markets legislation. We also do Tax, IFRS, Competition and monetary policy.

On financial markets we are the co-legislator with the Council and for those of you who may not be steeped in the European legislative process, I thought that I would very briefly and simply explain how it fits together, and then follow this with some brief points in my mind concerning derivatives and central clearing.

This should leave time for questions at the end. I always like to offer that because at least then my reply should be about something that at least one of you is interested in!

The Commission drafts and proposes legislation. There is usually a significant consultation period before a draft of legislation emerges, and as you will know currently there is consultation by the Commission concerning possible legislation on derivatives and central clearing.

Once draft legislation is formally released by the Commission, the Council and the Parliament operate as two legislative chambers independently scrutinising and amending the Commission's text. The detailed work for the Council is done by a working party of attaches from each Member State, led by whoever is in the current Presidency. Eventually the attaches will reach an agreement that they take to higher levels of the ambassadors or ministers for agreement or sometimes for specific political points.

In the Parliament the different political groups each have a lead person on each piece of legislation - one will be the main lead and called the rapporteur, and the others are called shadow rapporteurs, and they will usually be the most active MEPs on that legislative item. However any MEP can put forward amendments and play a significant part too. As well as open discussions in committee the MEPs will meet to thrash out compromises in smaller meetings.

In the ECON Committee we usually try to reach a first reading agreement with the Council, but in theory there can be three rounds.

When aiming for a first reading agreement, the Council and the Parliament each take their deliberations to a provisionally agreed position - which for us is a vote in Committee and for the Council is known as a general approach - then meet together to try and obtain an agreement between Council and Parliament. These meetings are called trialogues and usually have present from the Council side the Presidency negotiating team and an observing team from the next in line to be President. So right now if we had a trialogue the Swedes would be there to negotiate with Spain observing.

The Parliament side negotiating team is the Chair, so me, the rapporteur and shadows. Also present in an advisory capacity is the Commission. And the idea is that we go through the texts line by line, compare amendments and see whether we can agree or draft new compromise versions. When everything is agreed, we go to take our respective final votes on the agreed texts. This is quite a dynamic process, done face to face, rather than sterile exchange of texts.

Some people have drawn a parallel between the US House and Senate amending legislation separately and then having to agree with one another. Indeed in some ways it is simpler because we can not add in lots of unrelated bits and pieces.

If we can not agree, then we vote different texts and have to attempt a second reading. There are debates about the merits of first versus second reading agreements, but in the ECON committee we have a track record of being successful at first reading. The process can be a bit opaque especially if it is done fast, but normally there are gaps of a week or so between meetings and some circulation of papers of tentative agreements.

So this is a 50 50 process of Council and Parliament. If the commission do not like the agreement then they could withdraw the proposal altogether. They do not have the right to amend - they have had their go. But in practice they usually assist in the formulation of compromises.

Realistically from start to finish a first reading agreement takes a minimum of 6 months, usually longer because of the Parliament meeting cycle and the need for translation of documents and usually some hearings or workshops.

So, as I said, one of the things that is exercising your minds and mine is that the Commission have started consulting on clearing of derivatives. There was also a statement in President Barroso's manifesto that he would bring forward something substantial in the area of derivatives.

One thing I do know about Commission consultations and conferences is that they always choose to put the most interesting and important ones when I am far away from Brussels. So I guess that is why they have one tomorrow when the Parliament is on a constituency week. However, there has also been a period for submission of responses to their consultation paper and quite a few of them have also been sent to me. I think that many sensible and measured responses have been put forward.

Now the time for my committee to look at anything officially is some time away, and we do have our hands full with a lot of other legislation already on it way to us. However, we also have various exchanges with Commissioners, the President of the ECB and others at which issues such as derivatives will be discussed.

And as I have discovered before, it is necessary to keep alert to see what amendments might come sneaking along in the never ending story of amending the Capital Requirements Directive. So we are already surrounded by and in the opinion forming process, if not yet steeped in technical detail.

As a consequence of the financial crisis, Europe is not alone in having a slew of legislation. Some 15 bills are also out in the US. Many are on the same subjects as we have lined up. Policy made at meetings such as G20 will often end up as legislation and as there is not a global legislator we will discover that there will de differences in timing and content.

So what can we do about that? Well, we all have to do our bit to coordinate where we can. Industry does a lot in following the US and EU and making comparisons.

It is my intention that the ECON committee will also do its share as far as it can, and to that end the opening session of the first Committee meeting on 2 September was a general exchange of views about upcoming legislation with Congressmen from the US House markets subcommittee, led by Chairman Kanjorsky. This was the first time that there had been a Committee to Committee meeting in public and it was agreed that we would make serious efforts to keep in contact for detailed work with video conferencing and more frequent visits.

We also had a meeting with visiting Senators in the previous week and aim to maintain contact there too. And if I were not here today I would be in Brussels meeting Gary Gensler of the Commodities, Futures and Trading Commission, and we have already spoken by phone and agreed to keep in touch.

The downside of all this is that I now have twice as much to look at.

Turning now to make a few comments that strike me about derivatives and OTCs. They were not a major factor in the crisis, although of course some had worried about them for a while. Indeed one could argue that they performed better than expected, but the potential, or fear, for them to be abused was exposed.

In the political climate now it seems impossible to prevent legislation to increase or maximise use of central clearing, and the debate will centralise around what is the appropriate extent of central clearing.

It can be argued that the accelerated way in which Credit Default Swaps were dealt with as a separate category - and of course without legislation - sets a precedent that all derivatives are not the same. Therefore it must follow that looking forwards different types of derivatives and their risks could be dealt with separately or differently.

The US is ahead of the EU in its actual legislative proposals, and already there seem to be some sensible recognition that foreign exchange can be exempted and some kinds of hedging.

Some of the important points seem to be

1. Central clearing and effective central counterparties will be of benefit to those classes that lend themselves to appropriate levels of standardisation. However this will not be universally possible and so it is essential that some bespoke OTC products with remain.

2. Where bespoke products are needed, proper analysis should be made to determine risk rather than a blanket assumption made concerning application of measures such as capital charges. Possibly there can be restrictions placed on who can participate in that market.

3. When there is a direct interest in an underlying commodity such as is the case for many corporates legitimately hedging in ways that are allowed - or indeed even effectively mandated through other legislation or accounting standards - then levying additional costs beyond their normal credit lines is highly undesirable - not least when for some time we will be trying to effect a recovery in the real economy.

4. Maximising standardisation where it is appropriate is a good thing, enforcing standardisation where it does not fit could increase rather than reduce risk. It may well be possible to standardise contract terms in ways that leave flexibility in economic behaviour.

5. Transparency of trades and aggregate volumes is beneficial. There may be some exceptions

. 6. Allowing exceptions should be looked at from a risk perspective rather than a prescriptive basis. There may be some categories that could be left alone to function as now.

7. There needs to be competition and non discriminatory access between clearing venues and the risks of concentration are taken into account. Here we must think the unthinkable. It used to be unthinkable that the likes of Lehman or AIG would go down.

8. Getting appropriate supervision and governance systems and internationally consistent standards is important.

I am sure that there are a lot more points, sub points and detail that in the fullness of time I and other members of the ECON committee will be discussing.

There is also the matter of location of central counterparties and pressure for them to be in the Eurozone. This runs counter to the point I made about competition.

So, this is a summary of the process an my thoughts, but I can not yet speak for others in the committee. But I can reassure you that we are taking steps to be prepared and educated for when the matter does formally come to us.

ENDS