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EU Derivatives Reform

Comment 2nd September 2010

In principle British Land PLC supports the EU’s aim of improving transparency and reducing the systemic risk posed by the OTC derivatives market. However, it is imperative that the regulation does not, inadvertently, discourage the use of derivatives for hedging purposes. The use of derivatives, particularly interest rate swaps linked to loans, is widespread in the commercial property sector and does not contribute to systemic risk but instead enhances market stability.

The European Institutions have sensibly judged that a distinction needs to be drawn between financial businesses (who can use derivates in a speculative manner) and other businesses including property groups which use derivatives to provide cash flow certainty. The problem is largely definitional: it is vital to use as narrow a definition as possible (for example based on MiFID regulation) and to ensure that all non-financial businesses rather than just SMEs are excluded.

Two other important changes to the EU’s current proposals are needed: first in relation to risk mitigation for non-cleared contracts, any new regime must take account of non-cash security (such as underlying real estate assets) supporting the contract. Second, information and clearing thresholds for monitoring and regulating the use of derivatives by non-financial undertakings should specifically exclude interest rate swaps used for hedging purposes as proposed under the equivalent US regulations.
 

Why does this matter?

Failure to do so is likely to lead to the unintended consequence of an onerous regulatory burden and additional liquidity cost being placed on the wrong target – i.e. one not prone to systemic risk. As currently drafted property businesses risk being categorised as financial counterparties indirectly via the AIFM. A doubling up of unnecessary regulatory burdens is likely to add significant costs.


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